Transfer Pricing

The shocks and struts division of Transnational Motors Company produces strut assemblies for automobiles. It has been the sole supplier of strut assemblies to the automotive division and charges $45 per unit, the current market price for very large wholesale lots. The shocks and struts division also sells to outside retail outlets, at $57 per unit. Normally, outside sales amount to 25% of a total sales volume of 1 million strut assemblies per year. Typical combined annual data for the division follow:

Sales	$48,000,000
Variable costs, at $37.50 per strut assembly		$37,500,000
Fixed costs		4,500,000
Total costs	$42,000,000
Gross margin	$6,000,000

Flint Auto Parts Company, an entirely separate entity, has offered the automotive division comparable strut assemblies at a firm price of $42 per unit. The shocks and struts division of Transnational Motors claims that it cannot possibly match this price because it could not earn any margin at $42.

1. Assume that you are the manager of the automotive division of Transnational Motors. Comment on the shocks and struts division's claim. Assume that normal outside volume cannot be increased.

2. Now assume the shocks and struts division believes that it can increase outside sales by 750,000 strut assemblies per year by increasing fixed costs by $3 million and variable costs by $4.50 per unit while reducing the selling price to $54. Assume that maximum capacity is 1 million strut assemblies per year. Should the division reject intracompany business and concentrate on outside sales?