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Sungsam Electronics is a South Korean multinational conglomerate headquartered in Seoul, South Korea. It comprises numerous affiliated businesses, most of which operate under the Sungsam brand. Amongst others, its divisions manufacture memory chips, television screens and other consumer electronics; other divisions are active in construction and financial services.
The Memory Chips Division is manufacturing memory chips for mobile phones. The memory chips are sold internally to the Mobile Phone Division, as well as externally to other firms that manufacture phones (e.g. Apple, LG Electronics, Sony, etc). Total number of memory chips sold is 70,000; 40,000 are sold internally (to the Mobile Phone Division of Sungsam), the rest (30,000) is sold to outside parties. Total available capacity at the Chips Division is 100,000 units. The market price for the memory chips is €25; variable manufacturing costs are €7 per unit, and total fixed costs for the Chips Division are € 945,000. Fixed costs are allocated to products based upon the budgeted production of 70,000 units.
The Mobile Phone Division sells 40,000 phones; available capacity is 50,000 units. The sales price for the phone is €280; variable costs (in addition to the transferred in costs from the Chips Division) are
€65 and fixed costs are €6.5 mln for the Mobile Phone Division.
What is the profit for the Chips Division when the transfer price is set at market price?
Profit for the Chip Department will be
The manager of the Mobile Phone Division is arguing that the transfer price should be set at full cost plus 10%, the average profit margin for the Mobile Phone Division.
What is the profit for the Chips Division when the transfer price is set at full cost plus 10%?
The profit for the Chip division is
Will the choice for a market price or a full cost plus 10% price impact the choices of each division? Why or why not?
Since both units are operating below capacity, the choice of the transfer price does not matter: in both cases neither division will be better off if they refuse to engage in internal transfers
The Chips Division receives an offer from an outside party, which is willing to pay €18.50 for 20.000 memory chips. This outside party is unlikely to become a client of Sungsam for a longer period of time; in addition, it is not a competitor of the Mobile Phone Division nor for other divisions of Sungsam. The manager of the Chips Division refuses the offer, arguing that the price is below market price and below the full production costs of the Chips Division.