(Transfer Pricing) The Umber Company is a multidivisional company that manufactures toys. The Truck Division of the Umber Company has asked the Wheel Division to provide wheels that are required in the production of its toy monster trucks. Currently, the Wheel Division sells wheels only to outside customers for $4 per set of 4 wheels and is operating at capacity. The Truck Division, which is operating below capacity, wants to pay the Wheel Division $3 per set. The Wheel Division’s variable costs per set are $2. The toy monster truck made by the Truck Division currently costs $15 to make, as follows:
|
Plastic parts |
$ 6 |
|
Wheels (purchased outside) |
4 |
|
Conversion costs |
3 |
|
Fixed overhead |
2 |
|
Total cost per monster truck |
$15 |
The manager of Truck Division believes that the $3 price is fair since it covers the division’s variable costs.
- As manager of the Wheel Division, would you recommend that your division provide wheels to the Truck Division? If so, at what transfer price?
- How would your decision change if you had excess capacity?