Transcript Transfer pricing exercise

Team Exercise
• Transfer price: A transfer price is
what one part of a company
charges another part of the
company for a good or service.
• You are organized into teams of two, and
each team is matched with two other
teams (to form “super” teams of six).
• Choose a team leader. The team leader is
responsible for picking up, distributing,
collecting, and returning the index cards;
and also for handing in the one-page
write-up at the end of class. (A great honor
indeed; leadership has its rewards)
• The index cards consist of FOUR separate
scenarios. Each scenario is printed on a
different color index card: green, red,
yellow and blue.
• The team leader should hand out the red
cards to one team, the yellow cards to
another team, and retain the green and
blue cards for his/her own team.
• Each scenario is played one at a time,
starting with scenario 1 (green), and
proceeding through scenario 4.
• To play each scenario, do the following:
The team with the cards for that scenario
should retain the card that says “top
management”, give the “buyer” card to
one team, and the “seller” card to the
other team. Every team should get to
play buyer and seller at least once.
• The buyer team and seller team first talk
among themselves to devise a strategy for the
negotiations. Each division wants a favorable
transfer price, to maximize divisional profits.
• Then the buyer team and seller team negotiate
a transfer price.
• Top management has all of the information
from both sides. It is your job to intervene in
the negotiations only if it becomes clear that
the two divisions are not going to reach an
agreement. In this event, you should terminate
the negotiations and move on to the next
scenario.
• Top management also must record the outcome
on the one-page summary that will be handed
in at the end of class.
• REMEMBER:
– Play one scenario at a time; finish it, and go on to
the next scenario.
– Top management should not share information with
either division either before or during negotiations.
– Before negotiations, each team must determine
privately its strategy for negotiating. No eavesdropping by the other division.
– Every team gets to be the buyer at least once.
Scenario 1 (Green)
Seller:
Capacity
150,000 units
Demand
120,000 units
External Price
Regular Variable Cost
Cost savings on internal order
$14.00
$9.00
$1.00
Buyer:
Requirements
Market price
12,000 units
$14.00
Scenario 1 (Green)
Seller:
Excess capacity?
YES
Will be willing to accept a transfer as low as
$8.00 (regular variable cost of $9 less savings
of $1)
Buyer:
Will be willing to pay up to $14, but no more,
since you can buy externally for $14.
Scenario 2 (Red)
Seller:
Capacity
150,000 units
Demand
150,000 units
External Price
Regular Variable Cost
Cost savings on internal order
$15.00
$9.00
$2.00
Buyer:
Requirements
Market price
12,000 units
$14.00
Scenario 2 (Red)
Seller:
Excess capacity?
NO
Opportunity cost: lost contribution margin on
each external sale $15.00 - $9.00 = $6.00
To make at least $6.00 contribution margin on
an internal sale, the transfer price must be at
least ($9 - $2) + $6 = $13.
Buyer:
Will be willing to pay up to $14, but no more,
since you can buy externally for $14.
Scenario 3 (Yellow)
Seller:
Capacity
150,000 units
Demand
150,000 units
External Price
Regular Variable Cost
Cost savings on internal order
$15.00
$9.00
none
Buyer:
Requirements
Market price
12,000 units
$14.00
Scenario 3 (Yellow)
Seller:
Excess capacity?
NO
Opportunity cost: lost contribution margin on
each external sale $15.00 - $9.00 = $6.00
To make at least $6.00 contribution margin on
an internal sale, the transfer price must be at
least $9.00 + $6.00 = $15.00.
Buyer:
Will be willing to pay up to $14, but no more,
since you can buy externally for $14.
Scenario 4 (Blue)
Seller:
Capacity
150,000 units
Current Sales:
120,000 units externally at $14
12,000 units internally at $13
Regular Variable Cost
$9.00
(no cost savings on the internal orders)
Buyer:
You have received an offer to sell additional
product at $20. Variable cost is the cost of the
intermediate component plus $9.
Scenario 4 (Blue)
Seller:
Excess Capacity
YES
Variable cost is $9. You should be willing to
accept a transfer price as low as $9.
Buyer:
You are willing to pay up to $11 for the intermediate product for these additional sales: $20
selling price less $9 additional mfg cost = $11.
• Please turn in the cards, sorted
and paper-clipped as they were
handed out (Scenario 1 on top,
then 2, 3 and 4; within each
scenario, top management on top,
then buyer, then seller.
• Please turn in the one page writeup.