Dragoon has two manufacturing divisions:
• Costa Division
• Margarita Division.
The Costa Division produces electric motors, 20 per cent of which are sold to the Margarita of Dragoon. The remainder are sold to outside customers. Dragoon regards both divisions as centres and allows division managers to choose their sources of sale arid supply. Corporate policy requires that all interdivisional sales and purchases be made at a transfer price based on standard variable cost. Costa Division’s estimated sales and standard cost data for the year ending 31 December based on capacity of 100 000 units, are as follows:
Costa has an opportunity to sell the 20000 units that it currently sells to Margarita to a new outside customer at a price of $37.50 per unit. Margarita can purchase its requirements from an outside supple” at a price of $42.50 per unit.
1. Assuming that Costa Division desires to maxirnise its profits, should Costa take on the new Costa and drop its sales to Margarita? Explain your answer.
2. Assume, instead, that Dragoon permits division managers to negotiate the transfer price. The managers agree on a tentative transfer price of $37.50 per unit, to be reduced based on an equal sharing of the additional gross margin to Costa resulting from the sale to Margarita of 20 000 motors at $37.50 per unit. What would be the actual transfer price?
3. Assume now that Costa Division has an opportunity to sell the 20 000 motors that Margarita Division would buy to the same customers that are buying the other 80 000 motors produced by Costa. Costa Division could sell all 100 000 motors to outside customers at a price of $50. What actions by each division manager are in the best interests of Dragoon Corporation?
4. Under the scenario described in requirement 3, use the general transfer pricing rule to ca transfer price that Costa Divs0 should charge Margarita Division for motors.
5. Will the transfer price calculated in requirement 4 result in the most desirable outcome from the standpoint of Dragoon Corporation? Justify your answer.