The GrowPro Manufacturing Company Has a Division (Division P) That

The GrowPro Manufacturing Company has a division (Division P) that produces an essential ingredient used by the Lawn Division in making lawn fertilizer. Historically, 75% of Division P's output has been purchased by Division L and 25% has been sold to other fertilizer companies. The transfer price between Division P and Division L has been based on the outside sales price less selling and administrative expenses directly applicable to the outside sales. Last year, the transfer price was $35 per ton and Division P would like the same transfer price this year. However, the general manager of Division L has found an outside supplier who will sell the ingredient for $30 per ton. She would like to continue buying from Division P, but Division P's manager does not want to match the $30 price because he thinks that the margin is too small. Top management does not get involved in transfer pricing disputes, but rather, allows division managers to make their own decisions concerning internal or external purchases and sales.
The following information has been gathered regarding Division P's operations last year:
$$\begin{array} { l r r } & \text { Sales to L} & \text { External } \\\text { Sales } & \$ 4,200,000 & \$ 2 , 0 0 0 , 0 0 0 \\\text { Variable costs } & 3,000,000 & 1,000,000 \\\text { Fixed costs } & 360,000 & 120,000\end{array}$$
The information presented above is based on selling 120,000 tons internally and 40,000 tons externally.
Required:
(a) If Division L buys externally, Division P can increase its current external sales by only 20,000 tons. What arguments can the general manager of Division L make to help Division P to match the $30 price?
(b) Division L wants to use only one supplier, so Division P will either sell 120,000 tons to Division L or nothing. If Division L's capacity is 160,000 tons, how many units does Division P need to sell to outsiders at $50 per ton before it is better off selling to outsiders? Ignore any additional marketing costs which would be incurred to increase sales.

Correct Answer:

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(a)If the internal price is dropped to m...

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