Reference no: EM132648288

Transfer pricing

Zanello Inc., manufacturer of home appliances, is organized along decentralized lines, with each manufacturing division operating as a separate profit center (refrigeration, cooking, dishwashers, laundry and minor appliances).

Each division manager has been delegated full authority on all decisions involving the sale of that division's output both to outsiders and to other divisions of Zanello. The Laundry Division has in the past always purchased its requirement of a particular engine from the Engines Division that produces various types of engines for several appliances. However, when informed that the Engines Division is increasing its selling price to $20, the Laundry Division's manager decides to purchase the engine component from outside suppliers.

The Laundry Division can purchase the component for $17 on the open market. The Engines Division insists that, because of the recent installation of some highly specialized equipment and the resulting high amortization charges, it will not be able to earn an adequate return on its investment unless it raises its price. The Laundry Division's manager appeals to top management of Zanello for support in the dispute with the Engines Division and supplies the following operating data:

Laundry Division's annual purchase of engines: 10,000 units

Engine Division's variable cost per engine: $10

Engine Division's fixed costs per engine: $7

Required

Consider each requirement independently from the others

1. Assume that there are no alternative uses for internal facilities. Determine whether the company as a whole will benefit if the Laundry Division purchases the engine from outside suppliers for $17 per unit?

2. Assume that there are no alternative uses for Engines Division's facilities and that due to excess of supply of engines in the market, the price from outsiders suppliers drops $6. Should the Laundry Division purchase from outside suppliers?

3. Assume that the Engines Division can sell the 10,000 units to other customers at $20 per unit with variable marketing costs of $2 per unit. Determine whether Zanello will benefit if the Laundry Division purchases the 10,000 engines from outside suppliers at $17 per unit?