Transfer Pricing in PolyPack, Inc.

Overview of PolyPack's Containers Division

  • Company Context: The Containers Division of PolyPack, Inc. focuses on manufacturing reusable plastic storage containers for household and commercial applications.

  • Core Product: 32-ounce plastic container, sold both externally and internally to PolyPack's Food Services Division.

Cost and Sales Data for the 32-ounce Container

  • Unit Selling Price (External): $1.80

  • Unit Variable Cost: $0.70

  • Unit Product Fixed Cost: $0.40

    • Calculation: Based on $360,000 total fixed manufacturing costs divided by 900,000 units.

  • Practical Capacity: 900,000 units.

  • Expected External Demand: 650,000 containers.

  • Internal Purchase Plan: The Food Services Division intends to buy 250,000 comparable containers from a supplier for $1.75 each.

Transfer Pricing Offer

  • Managerial Negotiation:

    • Riley Chen (Containers Division) proposes to supply 250,000 containers internally at a price of $1.64 each.

    • This price allows the Containers Division to avoid $0.16/unit in packaging and distribution costs.

    • Riley suggests splitting the savings, offering Morgan Davis (Food Services Division) a $0.08 discount off the external selling price.

Required Analysis

1. Minimum Transfer Price for Containers Division

  • Definition: The minimum transfer price is the lowest price at which the Containers Division would agree to sell the product internally. It typically covers variable costs and any foregone contribution margin.

  • Calculation:

    • Minimum Transfer Price = Unit Variable Cost + Avoidable Costs

    • Minimum Transfer Price = unit variable cost of $0.70 (no fixed costs since they are sunk).

2. Maximum Transfer Price for Food Services Division

  • Definition: The maximum transfer price is the highest price that the Food Services Division would be willing to pay without exceeding external market options.

  • Calculation: Max Transfer Price = Price of external supplier = $1.75.

3. Decision on Internal Transfer

  • Assessment: The internal transfer should occur if the transfer price is less than the external purchase price ($1.75) and greater than or equal to the minimum transfer price ($0.70).

4. Benefit or Loss to PolyPack as a Whole from Internal Transfer

  • Assessment Parameters: Evaluate the impact on total company costs when choosing internal over external purchases, and the net benefit derived from avoiding packaging and distribution costs.

5. Benefit or Loss to Each Division from Internal Transfer

  • Assessment Parameters: Evaluate the financial outcome for both the Containers Division (in terms of contribution margin lost/gained) and the Food Services Division (cost savings vs. internal costs).

6. Willingness to Agree on Transfer Price Knowing Idle Capacity

  • Analysis: If Morgan (Food Services Division) is aware of the Containers Division's idle capacity, he is likely to be more inclined to negotiate a lower price since the Containers Division is not utilizing its full capacity. Hence, he might still agree to $1.64.

7. Counter Offer of $1.00 from Food Services Division

  • Analysis: Assess whether Riley would be interested in the offer based on potential gains compared to current pricing.

  • Support Computation: Compare the profitability of internal transfer pricing against the external options, factoring in costs and fixed contributions.

8. Policy of Full Manufacturing Cost for Internal Transfers

  • Definition: If PolyPack's policy mandates pricing based on full manufacturing costs (including both variable and fixed costs).

  • Calculation: Total manufacturing cost per unit = Variable cost + Fixed cost. For the 32-ounce container, the price would be:

    • Total Manufacturing Cost = $0.70 (variable) + $0.40 (fixed) = $1.10.

  • Decision Analysis: Compare this to external purchase price ($1.75). Since $1.10 is less than $1.75, the internal transfer should occur.

Revised Demand Scenario (Questions 9-13)

  • Assumption: Containers Division expects an external demand of 700,000 units.

9. Minimum Transfer Price at 700,000 Expected Demand

  • Analysis: Re-evaluate minimum transfer price under the scenario of expected increased production and sales capacity.

10. Maximum Transfer Price with Increased Demand

  • Analysis: Recalculate based on the new market conditions and expected sales capacity; reflect on external supply prices.

11. Decision on Internal Transfer under New Demand Conditions

  • Assessment: Reassess overall benefit to the divisions and company amidst higher demand expectations.

12. Overall Benefit or Loss to PolyPack from Internal Transfer under New Demand

  • Impact Evaluation: Determine financial outcomes for PolyPack and how an internal transfer influences overall profitability given the escalated capacity usage.

13. Individual Divisions' Benefits or Losses from Internal Transfer under New Demand

  • Differentiating Outcomes for Each Division: Calculate and contrast various financial scenarios for both divisions with the new demand context.