Textbook Problem

Transfer Pricing

GreenWorld Inc. is a nursery products firm. It has three divisions that grow and sell plants: the Western Division, the Southern Division, and the Canadian Division. Recently, the Southern Division of GreenWorld acquired a plastics factory that manufactures green plastic pots. These pots can be sold both externally and internally. Company policy permits each manager to decide whether to buy or sell internally. Each divisional manager is evaluated on the basis of ROI and EVA.

The Western Division had bought its plastic pots in lots of 100 from a variety of vendors. The average price paid was $75 per box of 100 pots. However, the acquisition made Rosario Sanchez-Ruiz, manager of the Western Division, wonder whether or not a more favorable price could be arranged. She decided to approach Lorne Matthews, manager of the Southern Division, to see if he wanted to offer a better price for an internal transfer. She suggested a transfer of 3,500 boxes at $70 per box.

Lorne gathered the following information regarding the cost of a box of 100 pots:

*Fixed overhead is based on $200,000/20,000 boxes.

Required:

1. 1. CONCEPTUAL CONNECTION Suppose that the plastics factory is producing at capacity and can sell all that it produces to outside customers. How should Lorne respond to Rosario’s request for a lower transfer price?
2. 2. CONCEPTUAL CONNECTION Now assume that the plastics factory is currently selling 16,000 boxes. What are the minimum and maximum transfer prices? Should Lorne consider the transfer at $70 per box?
3. 3. CONCEPTUAL CONNECTION Suppose that GreenWorld’s policy is that all transfer prices be set at full cost plus 20%. Would the transfer take place? Why or why not?