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 Transfer Pricing   The California Hitech Company (CHC) consists of the semiconductor division and the PC division, each of which operates as an independent profit center

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 Transfer Pricing

 

The California Hitech Company (CHC) consists of the semiconductor division and the PC division, each of which operates as an independent profit center.

The semiconductor division employs skilled workers who produce two different electronic components, the new high performance Mega-Chip and an older product called Okay-Chip. These two products have the following cost characteristics:

 

                                                                        Mega-Chip                 Oaky-Chip 

Material – parts                                   $ 2.00                          $ 1.00

Direct labor (at $14 per hour)              28.00                             7.00

Total                                        $30.00                          $8.00

 

The annual overhead in the semiconductor division totals $400,000, all fixed. Owing to the high skill level necessary for the workers, the semiconductor division’s capacity is set at 50,000 hours per year.

 

To date, only one customer has developed a product utilizing Mega-chip, and this customer orders a maximum of 15,000 Mega-chip orders per year, at a price of $60 per chip. If CHC cannot meet this customer’s entire demand, the customer has to curtail its production. The rest of the semiconductor division’s capacity is devoted to Okay-chip, for which there is unlimited demand at $12 per chip. 

 

The PC division produces only one product, a process-control unit, which requires a complex circuit board imported from Sweden at a price of $60. The control unit’s costs are:

            Direct material:

circuit board       60.00 other parts               8.00

Total direct material                                                                $68.00 

            Direct labor (5 hours @ $10 per hour)                                                $50.00

 

The PC division is composed of only a small assembly plant, and all overhead is fixed at a total of $80,000 per year. The current market price for the control unit is $140 per unit. A joint research project has just revealed that with minor modifications, a single Megachip could be substituted for the circuit board currently used by the PC division. The modification would require an extra 1 hour (increasing the total to 6 hours per control unit) and additional $ 1 in parts (increasing the material cost to $69 per unit). 

 

 

 

 

 

Required:

 

1. If no transfers of Mega-chip are made to the PC division, how many Mega-chips and Okay-chips should the semiconductor division sell? Show your computations.

 

2. The PC division expects to sell 5,000 control units at $140 per unit. From the overall viewpoint of CHC, how many Mega-chips should be transferred to the PC division to replace the Swedish circuit boards? What transfer price will ensure that the divisional managers’ actions maximize the profit of the company as a whole.

 

3. Suppose now that the demand for the control unit is still 5,000, but its price is $116 per unit. (All other data are unchanged.)

 

1. 1. From the overall viewpoint of CHC, how many units of control units should the PC division produce, and how many Mega-chips should be transferred internally?

 

1. 2. Suppose further that the corporate headquarters has fixed the transfer price at $48 per unit of Mega-chips. Acting in its own interests, how many control units would the PC division produce? What transfer price of Mega-chip would ensure that the divisional managers’ actions maximize the profit of the company as a whole?