Mcfrankel Engineering Case Study

McFrankel Engineering Transfer Pricing

Case Study

Purchase parts from outside vendors | € 22.50 |

Emission Control fitting TAR21 | € 5.00 |

Other variable costs | € 14.00 |

Fixed overhead and administration | € 8.00 |

Total cost per catalytic converter unit | € 49.50 |

1. Assume that you are the manager of the Emission Control Division. Would you recommend that your division supply the TAR21 fitting to the Electronic Fuel Injection Division for €5 each as requested? Why or why not? Show all computations.

Transfer Price = Variable Cost Per Unit + (Total Contribution Margin On Lost Sales/Number of Units Transferred)

= €4.25 + (€7.50 - €4.25)

= €4.25 + €3.25

= €7.50 (minimum transfer price – should not go under this price)

The Emission Control Division should not sell it for €5 each. If the Emission Control Division wants to buy from us internally, they should pay €7.50. If the Emission Control Division does sell it for €5, then they must give up revenues of €7.50 on each of the fitting, reducing our ROI, which will curve the overall company profits. The company will be worst off in this case.

2. Would it be profitable for the company as a whole for the Emission Control Division to supply the fittings to the Electronic Fuel Injection Division if the airplane catalytic converter units can be sold for €50? Show all computations, and explain your answer.

Selling price of the catalytic converter units |   | € 50.00 |

Cost of fittings used in catalytic converters | € 7.50 |   |

Variable costs of the Electronic Fuel Injection Division excluding fitting | € 36.50 | € 44.00 |

Net positive effect on the company's profit |   | € 6.00 |

The key is to recognize the €8.00 in fixed overhead and administration which we do not want to include the €49.50 is not the relevant cost and only want to include the variable cost. When we take out the fixed costs, we will still be under the €50 contract price to win the bid if they...