Europa, Inc

Europa, Inc.

Pertinent transfer price. Europa Inc., has two divisions, A and B, which manufacture expensive bicycles. Division A produces the bicycle frame, and Division B assembles the best rest of the bicycle onto the frame. There is a market for both the subassembly and the final product. Each division has been designated as a profit center. The transfer price for the subassembly has been set at the long-run average market price.

The following data are available to each division:

Estimated selling price for the final product $300Long-run average selling price for intermediate product 200Outlay costs for completion in Division B 150Outlay costs in Division A 120

The manager of Division B has made the following calculation:

Selling price---final product $300Transferred-in costs (market) $200Outlay costs for completion 150 350Contribution (loss) on product $(50)

Required1. Should transfers be made to Division B if there is no excess capacity in Division A? Is the market price the correct transfer price?

2. Assume that Division A's maximum capacity for this product is 1,000 units per month and sales to the intermediate market are now 800 units. Should 200 units be transferred to Division B? At what transfer price? Assume that for a variety of reasons A will maintain the $200 selling-price indefinitely; that is, A is not considering cutting the price to outsiders even if idle capacity exists.

3. Suppose A quoted a transfer price of $150 for up to 200 units. What would be the contribution to the company as a whole if the transfer were made? As manager of B, would you be inclined to buy at $150?

Pricing in imperfect markets. Refer to the Europa problem above.

Required

1. Suppose the manager of Division A has the option of (a) cutting the external price to $195 with the certainty that sales will rise to 1,000 units or (b) maintaining the outside price of $200 for the 800 units and transferring the 200 units to Division B at some price that would produce the same operating income for Division A. What transfer price would produce the same operating income for Division A? Does that price coincide with that produced by the "general guideline" in the chapter, so that the desirable decision for the company as a whole would result?

2. Suppose that if the selling price for the intermediate product is dropped to $195, outside sales can be increased to 900 units. Division B wants to acquire as many as 200 units if the transfer price is acceptable. For simplicity assume that there is no outside market for the final 100 units of Division A capacity.

a. Using the "general guideline," what is (are) the transfer price(s) that should lead to the correct economic decision? Ignore performance evaluation considerations.

b. Compare the total contributions under the alternatives to show why the transfer price(s) recommended lead(s) to the optimal economic decision.