Reference no: EM133140391

Question - Transfer pricing - Squish Corp. has two divisions: Production (which makes pillow foam) and Assembly (which makes pillows). Division managers can choose to purchase components internally or externally. For each pound of foam, the Production Division incurs $4 of variable cost and $1 of fixed cost with a production capacity of 30,000 pounds per month; the division recently increased its transfer price to Assembly to $5.50 to cover full production cost and provide a profit margin to the Production Division. Assembly's manager has decided to begin purchasing foam externally for $4.50 per pound.

a. Assume that Production Division has no alternative uses for its manufacturing facilities. Fixed costs could not be avoided by external purchases. What is the monthly advantage (or disadvantage) to Squish Corp. if the foam is purchased internally?

b. Assume that, rather than manufacturing foam, the Production Division manufacturing facilities can be rented for $25,000 per month. What is the monthly advantage (or disadvantage) to Squish Corp. if the foam is purchased internally?

c. Assume that Squish decides to stop internal foam production and rent out the facilities for $25,000 per month. Thus, Assembly Division begins buying all of its production needs externally at $4.50 per pound. What short- or long-term effects would these transactions have on Squish Corp.?