5 Case 11A-7 Transfer Pricing: Divisional Performance [LO11-5) 10 points Weller

Question

5 Case 11A-7 Transfer Pricing: Divisional Performance [LO11-5) 10 points Weller Industries is a decentralized organization with six divisions. The company's Electrical Division produces a variety of electrical items, including an X52 electrical fitting. The Electrical Division (which is operating at capacity) sells this fitting to its regular customers for $13.70 each: the fitting has a variable manufacturing cost of $8.55. The company's Brake Division has asked the Electrical Division to supply it with a large quantity of X52 fittings for only $9.10 each. The Brake Division, which is operating at 60% of capacity, will put the fitting into a brake unit that it will produce and sell to a large commercial airline manufacturer. The cost of the brake unit being built by the Brake Division follows: eBook Purchased parts (from outside vendor) 35.00 Electrical fitting X52 Other variable costs Pixed overhead and administration 9.10 21.40 12.00 Print Total cost per brake unit $77.50 References Although the $9.10 price for the X52 fitting represents a substantial discount from the regular $13.70 price, the manager of the Brake Division believes the price concession is necessary if his division is to pet the contract for the airplane brake units. He has heard through the grapevine" that the airplane manufacturer plans to reject his bid if it is more than $77.75 per brake unit. Thus, if the Brake Division is forced to pay the regular $13.70 price for the X52 fitting, it will either not get the contract or it will suffer a substantial loss at a time when it is already operating at only 60% of capacity. The manager of the Brake Division argues that the price concession is imperative to the well-being of both his division and the company as a whole. Weller Industries uses return on investment (ROD to measure divisional performance. Required: 1. Assume that you are the manager of the Electrical Division. a. What is the lowest acceptable transfer price for the Electrical Division? b. Would you supply the X52 fitting to the Brake Division for $9.10 each as requested? 2. Calculate the net positive effect on the company's profit per brake unit the Electrical Division to supply the fittings to the Brake Division and if the airplane brakes can be sold for $7775? 3. In principle, within what range would that transfer price lie?

Explanation / Answer

1)a. Lowest acceptable transfer price = Variable Cost per unit + Contribution lost

= $8.55 + ($13.70 - $8.55)

= $13.70

1)b. No the Electrical Division will not be ready to sell X52 fitting to the Brake Division for $9.10 each as requested.

2). Financial Advantage = Sale Price - Purchase parts - X52 part cost - Other Variable Costs

= $77.75 - $35 - $13.70 - $21.40

= $77.75 - $70.1

= $7.65

4). Highest Acceptable Price can be = $7.65 + $13.70

= $21.35

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