Transfer Pricing:

Hasbro's My Little Pony Division (MLP) is a toy line and media franchise. The first 'little ponies' were produced in 1981. They feature colorful bodies, manes and a unique symbol on one or both sides of their flanks. MLP sells 20,000 batches of ponies each year (batches are standard size, comprising 12 ponies per box). It has two options, it could:

1. Purchase batches from the Littlest Pet Shop division of Hasbro. This division already makes miniature animal models similar to the ponies, or
2. Purchase plastic pony models from an external supplier, Plastic Horse Bodies, Inc. (PHB). PHB agrees to meet all of Hasbro's quality requirements and is currently negotiating with MLP to supply 20,000 batches of ponies at a price between $65 and $90 per batch.

A critical component of each pony is the unique symbol on one or both sides of the pony's body. Such symbols are referred to as "cutie marks". These require careful etching as well as a specific and expensive inking process. To ensure the quality of the product, Hasbro requires that if PHB wins the contract to supply ponies, it must use the services of Hasbro's Littlest Pet Shop division for the etching and inking. This would cost PHB $40 per batch of ponies.

The Littlest Pet Shop division can manufacture at most 22,000 batches of ponies annually

The Littlest Pet Shop division provides special etching and inking for its own range of animal figures, as well as for other Hasbro divisions. Hence, it is geared up to provide as much of this service as can be sold. For the Littlest Pet Shop division, the incremental cost of the etching and inking process is $30 per batch, and the incremental cost of manufacturing a batch of ponies (including the cost of the etching and ink) is $50 per batch.

While Hasbro would not allow the Littlest Pet Shop division to sell MLP-trademarked products (i.e., My Little Ponies), the ponies can be transformed into Littlest Pet Shop characters for the same incremental production cost via a different sequence of etching and inking. In other words, the incremental cost of manufacturing a batch of Littlest Pet Shop division products would also be $50 per batch.

There is an external market for batches of the MLP ponies and the Littlest Pet Shop division re-engineered products. Any number of batches can be sold for $70 each in the external market.

COMPLETE THE FOLLOWING FOR HOMEWORK:

1. What are the incremental costs minus revenues from sale to external buyers for Hasbro if the Littlest Pet Shop division transfers 20,000 batches of ponies to the assembly division at MLP and sells the remaining 2,000 as re-engineered Littlest Pet Shop division batches on the external market?
2. What are the incremental costs minus revenues from sales to external buyers for Hasbro if the Littlest Pet Shop division sells 22,000 batches of re-engineered ponies on the external market, and MLP accepts PHB's offer at (a) $65 per batch of ponies or (b) $90 per batch of ponies?
3. What is the minimum transfer price per batch of ponies at which the Littlest Pet Shop division would be willing to transfer 20,000 batches of ponies to the assembly division?