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| Within Sparta Enterprises, the extraction division transfers 100% of its total output of 500,000 units of a particular type of clay to the pet products division, which treats the clay and sells it as cat litter for $42 a unit. The pet products division currently pays a transfer price for the clay of cost plus 10%, or $22 a unit. The clay has many other uses and could be sold in the marketplace for $26 in virtually unlimited quantities. If the extraction division did sell the clay into the wider market, it would incur a variable selling cost of $1.50 per unit. The extraction division recently hired a new manager, Keith Richardson, who immediately complained to top management about the disparity between the transfer price and the market price. For the most recent year, the pet products division's contribution margin on the sale of 500,000 units of cat litter was $5,775,000. The extraction unit's contribution margin on the transfer of an equal number of units of clay to the pet products division was $1,625,000. Refer to the Unit Cost Structure chart for more information.  Questions A. Why don't cost-based transfer prices provide an appropriate measure of divisional performance? B. Using the market price for the clay, what is the contribution margin for the two divisions for the most recent year? C. What price range for the clay would be acceptable to both divisions if Sparta instituted negotiated transfer pricing and allowed the divisions to buy and sell clay on the open market? Explain your answer. D. Why should a negotiated transfer price result in desirable behavior from the management of the two divisions? |