The Transfer Price Company has two divisions (Intermediate and Final) that report to the corporate office (Corporate). The two divisions are profit centers. Intermediate produces a proprietary product (called “intermed”) that it sells both inside the firm to Final and outside the firm. Final can only pur-chase intermed from Intermediate because Intermediate holds the patent to manufacture intermed . Intermed’s variable cost is $ 15 per unit, and Intermediate has excess capacity in the sense that it can satisfy demand from both its outside customers and Final. Final buys one intermed from Intermediate, incurs an additional variable cost of $ 5 per unit, and sells the product (called “final”) to external consumers. Final faces the following demand schedule for final.

Quantity Price

4......... $ 420

5......... 400

6......... 380

7 .........360

8......... 340

9 .........320

10......... 300

11 .........280

12......... 260

13......... 240

Required:

a. Calculate the quantity- price combination of final that maximizes firm value. In other words, if Corporate knew the variable costs of the two divisions, for what price would they sell final, and how many units of intermed would Corporate tell Intermediate to produce and transfer to Final? b. Assume that the managers in Corporate do not know the variable costs in the two divisions. Intermediate has the decision rights to set the transfer price of intermed to Final. Intermediate knows Final’s variable cost of $ 5 and the demand schedule Final faces for selling final to its customers. Intermediate, therefore, knows that the following schedule explains how many units of intermed Final will purchase given the transfer price Intermediate sets:

Transfer Price Quantity of intermed Purchased by Final

$ 220.............. 7

230.............. 7

240.............. 6

250.............. 6

260.............. 6

270.............. 6

280 ..............5

290 ..............5

In other words, if Intermediate sets a transfer price of $ 260, Final will purchase six units of intermed and produce 6 units of final . Given the above schedule of possible transfer prices that Intermediate can choose, what transfer price will Intermediate set to maximize its profits? c. While Corporate does not know intermed’s variable cost, it does know that the total cost of intermed is $ 48 per unit. This $ 48 per unit cost consists of both the variable costs to manufacture intermed plus the allocated fixed manufacturing costs. Intermedi-ate allocates all its fixed costs over all the products it produces, including intermed. If Corporate sets the transfer price of intermed at $ 48, how many units of intermed will Final purchase? d. What is the dollar impact on Intermediate’s profits if Final purchases the number of intermeds calculated in part ( c )?

e. Should Corporate allow Intermediate to set the transfer price for intermed that you calcu-lated in part (b), or should Corporate set the transfer price at $ 48 as in part (c)? Support your recommendation with a quantitative analysis.