Transfer Pricing; Decision Making Bramwell Adhesives, Inc, manufactures chemicals and adhe- sives for commercial and industrial use. Division A is currently purchasing 300 barrels per year of a required chemical (PB4) from an outside supplier for $550 per barrel. The $550 price is a com- petitive, fair price, but Division A is not satisfied with the service and reliability of the supplier. Fortunately, Division A has discovered that another Bramwell division, Division B, has the technol- ogy to manufacture PB4. Division B would have to purchase some new equipment to produce PB4, but the equipment is readily available and can be installed in a timely manner for $90,000. With the purchase of the machine, Division B would have the capacity to produce up to 1,000 barrels of the chemical per year. Division A would be willing to commit to a three-year contract for 300 barrels per year if the divisions could agree on a transfer price.
Division B projects the following costs per barrel for PB4.
|
Variable manufacturing cost
|
$200
|
|
Fixed costs per barrel*
|
300
|
|
Profit margin for Division B (20% of total cost)
|
100
|
|
Total projected price of PB4 to Div A
|
$600
|
* Allocation of the cost of purchased equipment over three years, based on an assumed production of 300 barrels in each of the three years.
Required
1. Is the purchase of the new equipment for $90,000 relevant to the decision to transfer internally and/or the determination of the transfer price?
2. Should Division B sell PB4 to Division A and, if so, at what price?