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AMIS 525

Transfer Pricing Example Problem The Dranik Company has two divisions -- the Motor Division and the Appliance Division. The Motor Division makes and sells Z99 model motors which can be sold to outside customers or to the Appliance Division to make washing machines. Appliance wants a single source supplier. The following data are expected for a month of operations by the Motor Division: selling price to outside customers variable cost of production per unit monthly capacity to produce Z99 motors Appliance can purchase a similar motor from an outside supplier for $110. $115 $75 3,500

1.

If outside demand for Z99 motors is 2,100 units and if Appliance wants to buy 1,200 motors from Motor during the month at the price of $110 per motor, what would be the effect on income for the month for the Dranik Company compared to buying from the outside supplier?

SOLUTION 1. EQ = 2,100 IQ = 1,200 tp = $110 buy inside cost is 1,200 @ $75 = buy outside cost is 1,200 @ $110 = advantage of inside source

$90,000 $132,000 ($42,000)

2.

If outside demand for Z99 motors is 2,840 units and if Appliance wants to buy 1,200 motors from Motor during the month at the price of $110 per motor, what would be the effect on income for the month for the Dranik Company compared to buying from the outside supplier?

SOLUTION 2. EQ = 2,840 IQ = 1,200 tp = $110 buy inside cost is 1,200 @ $75 = opportunity cost is 540 @ $40 = buy outside cost is 1,200 @ $110 = advantage of inside source

$90,000 $21,600 $111,600 $132,000 ($20,400)

3.

If outside demand for Z99 motors is 2,840 units and if Appliance wants to buy 1,200 motors for Motor during the month, what is the minimum price per motor which Motor would accept for the units sold to Appliance?

SOLUTION 3. EQ = 2,840 IQ = 1,200 tp = $110 cost is 1,200 @ $75 = opportunity cost is 540 @ $40 = $90,000 $21,600 $111,600 $18 $75 $93

oc = v=

$21,600 / 1200 = producer's minimum tp

4.

If outside demand for Z99 motors is 2,840 units and if Appliance wants to buy 1,200 motors from Motor during the month at the price of $95 per motor, what would be the effect on income for the month for each division?

SOLUTION 4. EQ = 2,840 IQ = 1,200 tp = $95 seller's contribution is 1,200 @ [ $95 - $18 - $75 ] = buyers's contribution is 1,200 @ [ $110 - $95 ] =

$2,400 $18,000 $20,400

5.

If outside demand for Z99 motors is 2,840 units and if Appliance wants to buy 1,200 motors for Motor during the month, what is the price per motor which would result in an equal [fair?] impact on income for the month for each division?

SOLUTION 5. EQ = 2,840 IQ = 1,200 tp = $101.50 seller [ tp - $18 - $75 ] = buyer [ $110 - tp ]

seller's contribution is 1,200 @ [ $101.5 - $18 - $75 ] = buyers's contribution is 1,200 @ [ $110 - $101.5 ] =

$10,200 $10,200 $20,400

1/9/2014