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Calculate Estimated Selling Price And Minimum Transfer Price

Question

Hamid Jones is a regional manager of Solar Sparks Corporation, an alternative energy firm developing, manufacturing, and exploiting photovoltaic technologies. Hamid is in charge of the European unit of Solar Sparks. His unit’s sole activity is to manufacture and sell Wafers. The unit manufactures 270,000 Wafers and is operating at 90 percent of theoretical capacity. The European unit currently sells these Wafers to outside customers at £100 per Wafer. The European unit incurs £25 in variable manufacturing costs per Wafer and £5 in variable selling costs when selling to outside buyers. The unit also incurs £1,350,000 in total fixed costs. The European unit could produce at up to 95 percent of its theoretical capacity without disruptions to current production or the need of additional investment. Hamid does not plan (nor have the resources) to make any investments in additional capacity in the foreseeable future. Jacob Kane, another regional manager of Solar Sparks, is in charge of the North American unit of Solar Sparks. Jacob has asked the Hamid to supply 50,000 Wafers from the European unit to the North American unit. The North American unit manufactures and sells Modules, and Wafers are a key input. The North American unit is currently operating at 50 percent of practical capacity due to a low supply of Wafers. The unit utilizes 100,000 Wafers to manufacture 400,000 Modules. Jacob has offered to pay Hamid's unit £60 per Wafer for the 50,000 Wafers (expected to yield 200,000 new Modules). At the North American unit, the full-absorption cost to manufacture and sell a Module currently consists of £40 for parts in addition to the cost of the Wafers, £30 for other variable costs per unit, and an allocation of £10 in fixed costs. The production of additional Modules would not alter the variable costs per unit and would not require any changes to fixed costs (the North American unit would be able to utilize currently idle capacity).Based on target costing, the manager of the North American unit has decided that a price higher than £60 per Wafer would be infeasible based on the expected selling price of the additional Modules. Solar Sparks evaluates managers on the basis of pretax ROI of the manager's unit (ignore taxes).

Required:

  1. What is the estimated target selling price per Module of the additional Modules if the production and sale of the new Modules are expected to generate £2,000,000 in additional pretax profits to the North American unit given the proposed transfer price?
  2. What is the minimum transfer price at which Hamid Jones would supply Wafers to the North American unit without adversely affecting his performance evaluation? Considering Hamid's performance evaluation system, would he supply Wafers to the North American unit at £60 per Wafer?
  3. Would it be in the economic interests of Solar Sparks for the European unit to supply the North American unit with 50,000 Wafers?
  4. Briefly discuss the organizational and behavioural difficulties, if any, inherent in this situation. As Hamid Jones, what would you advise the CEO of Solar Sparks to do in this situation?

Summary

The question belongs to Accounting and it discusses about calculation of estimated selling price and minimum transfer price for a company.

Total Word Count 640

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