Pegasus Technology Ltd (PTL) has two divisions: Adelaide and Sydney. Sydney currently sells a diode reducer to manufacturers of aircraft navigation systems for $2325 per unit. Variable costs amount to $1500, and demand for this product currently exceeds the division’s ability to supply the marketplace.
Despite this situation, PTL’s head office management is considering another use for the diode reducer, namely, integration into a satellite positioning system that would be manufactured by Adelaide. The positioning system has an anticipated selling price of $4200 and requires an additional $2010 of variable manufacturing costs. A transfer price of $2250 has been established for the diode reducer.
Head office management anxious to introduce the new positioning system. However, unless the transfer is made, an introduction will not be possible because of the difficulty of obtaining the needed diode reducers from the external market. The Sydney and Adelaide divisions are in the process of covering from financial problems and neither division can afford any further losses. The company uses return on investment (ROI) to measure divisional performance and awards bonuses to divisional management based on their division’s performance.
1. How might Sydney’s divisional manager react to the decision to transfer diode reducers to Adelaide? Show calculations to support your answer.
2. How might Adelaide’s divisional management react to the $2250 transfer price? Show calculations to support your answer.
3. Assume that a lower transfer price is desired. Should head office management lower the price or should the price be lowered by another means? Explain.
4. From a contribution margin perspective, does PTL benefit more if it sells the diode reducers externally or transfers the reducers to Adelaide? By how much?