Chapter 19 Exercises

Step-by-Step Exercises

Long-Run Pricing for External Customers

Calculate total sales units and the total costs of the product over its life cycle.

Question 1

Jellman Company is considering developing a product that will cost $50 per unit in direct materials and will require 4 hours of direct labor to manufacture, costing $10 per hour. Jellman applies variable manufacturing overhead at a rate of 75% of direct labor costs. Producing the product will require Jellman to incur fixed manufacturing overhead costs of $240,000 per year. Jellman estimates that they will spend $4,000,000 on advertising, marketing, and administrative expenses for the product over its 10-year life, during which time an average of 3,000 units will be sold each year.

Calculate total sales units and the total costs of the product over its life cycle.

Question 2

Penji Corporation is considering starting research and development on a new product with a 15-year life. Development and manufacturing setup will cost $12,000,000. Once production starts, direct materials will cost $12 per unit, and each unit will use 0.5 hour of direct labor at $15 per hour. Variable manufacturing overhead is applied at a rate of $10 per direct labor hour. The only fixed manufacturing overhead expense that will be affected is depreciation on the equipment purchased during manufacturing setup. Penji plans to spend $100,000 per year on marketing, advertising, and administration. Penji believes that demand for the product will be 100,000 the first year, will increase by 25% each of the next 2 years, then decrease by 10% each year thereafter.

Calculate total sales units and the total costs of the product over its life cycle.

Question 3

Chocco Toys has developed a toy that they believe will be the hot new toy for the holidays this year. Demand for the toy is expected to be 8,000,000 this year, but will drop to 500,000 next year, and go down to 10,000 the third year, after which Chocco believes that they will not be able to sell the product anymore. Up-front development costs are expected to total $10,000,000, and up-front advertising is expected to cost $2,000,000. Other fixed costs are expected to total $1,000,000 over the life of the product. The product will cost $1 in direct materials and $2 in direct labor per unit. Chocco applies variable overhead to products at 200% of direct labor costs.

Calculate total sales units and the total costs of the product over its life cycle.

Calculate estimated total revenue.

Question 4

Jiggins Company has developed a product that is estimated to sell 100,000 units and cost $5,240,000 over its life. Jiggins sets prices at 15% above full costs.

Calculate estimated total revenue.

Question 5

Mercury, Inc. is considering developing a product that will cost $20,000,000 plus a sales commission of 5% of revenues over its entire life. Demand for the product is expected to total 400,000 units. Mercury sets prices to achieve a 10% profit.

Calculate estimated total revenue.

Question 6

Alexander Corporation wants to market a product that will cost $510,000 over its life. Demand for the product is expected to total 5,000 units. Alexander believes that they can achieve a 30% profit margin on this product.

Calculate estimated total revenue.

Divide estimated total revenue by total estimated unit sales to calculate the long-run price per unit.

Question 7

Total revenue is estimated to be $7,250,000, and unit sales are estimated to be 2,500,000 over the life of the product.

Calculate the long-run price per unit.

Question 8

The company plans to sell 150,000 units over the life of the product. Revenues will need to be $4,500,000 to earn the company’s desired profit.

Calculate the long-run price per unit.

Question 9

Total estimated revenue is $800,000 over the 3-year life of the product, during which the company expects to sell 1,600 units.

Calculate the long-run price per unit.

Short-Run Pricing for External Customers

Question 10

Jenkins Company recently discontinued sales of one of their products, but still has 2,000 units remaining in inventory. The units cost $40 each to make and sold for $75. Jenkins could use the products for parts, which they estimate will generate $15 in savings per unit. Another firm has offered to purchase the remaining units in inventory.

Calculate the minimum price per unit the company should accept.

Question 11

Zolla Manufacturing has an excess capacity of 500 units in their manufacturing facility. Their product costs $1,000 per unit in variable costs plus $450 in allocated fixed manufacturing overhead. Another firm wishes to purchase 400 units from Zolla that they will repackage and sell under a different brand name; this would be a one-time-only special order. To fill the order, Zolla would need to retool their machinery to remove the Zolla logo, which would cost $6,400.

Calculate the minimum price per unit the company should accept.

Question 12

Annor Clothing wishes to place a stock of 100 holiday sweaters on clearance after the holiday season. The sweaters cost Annor $25 and sold for $50 during the holiday season. Annor will incur opportunity costs of $7 per sweater for rack space and will spend $500 to advertise the clearance sale.

Calculate the minimum price per unit the company should accept.

Transfer Pricing

Calculate transfer price based on variable cost.

Question 13

Moona Company has two divisions. Division A produces a component that they transfer to Division B, who uses the component in their main product. Division A incurs $400 in variable costs to manufacture each component, as well as $100,000 in fixed costs. Division B incurs $1,000 in variable costs in addition to the cost of the component to manufacture the main product, as well as $700,000 in fixed costs. Division A could sell the components on the market for $700. Moona sets transfer prices at variable cost plus 40%.

Calculate the transfer price.

Question 14

Gruber Corporation manufactures the components of their products at the Parts Manufacturing division. Each component costs $15 in variable costs to produce. The components are transferred to the Assembly division, where they are assembled into the final product, which costs $30 per unit plus the cost of components from the Parts Manufacturing division. Fixed costs are $200,000 for Parts Manufacturing and $350,000 for Assembly. The Parts Manufacturing division could sell the components on the market for $25. Gruber sets their transfer prices at variable cost plus 20%.

Calculate the transfer price.

Calculate transfer price based on full cost.

Question 15

Rory Company manufactures goods in Division A that are transferred to Division B for use in their products. Division A’s costs are $25 per unit, plus $10,000,000 in fixed costs. Division B’s costs are $100 per unit plus the cost of the transferred goods and $24,000,000 in fixed costs. Division B needs 200,000 units from Division A per year, which Division A could instead sell on the market for $150 each. Rory sets transfer prices at full cost plus 5%.

Calculate the transfer price.

Question 16

Obladi, Inc. manufactures 50,000 parts per year in the Parts division, which are transferred to the Finishing division. The Parts division’s costs are $3 per unit plus $200,000 in fixed costs. The Finishing division’s costs are $20 per unit plus the cost of the transferred parts and $500,000 in fixed costs. The market price for parts is $10. Obladi sets transfer prices at full cost plus 10%.

Calculate the transfer price.

Calculate transfer price based on market price.

Question 17

Gover, Inc. transfers 100,000 units from Division A, which manufactures them at a cost of $20 per unit plus $1,000,000 in fixed costs, to Division B, which finishes them at a cost of $7 per unit plus $200,000 in fixed costs, then sells the finished product for $50. Division A could sell the unfinished units on the market for $35. Gover sets their transfer prices at 5% below market price.

Calculate the transfer price.

Question 18

Silvan Company has two divisions. Alpha division manufactures components for $3,000 per unit plus $1,000,000 in fixed costs, which are transferred to Omega division for use in manufacturing the firm’s finished product, which costs an additional $5,000 per unit plus $3,000,000 in fixed costs. Omega division sells the final product for $10,000 per unit. Both Alpha and Omega divisions have an annual capacity of 4,000 units. Alpha could sell the components on the open market for $3,750. Silvan sets their transfer prices at 10% above market price.

Calculate the transfer price.

Find the range of transfer prices in a negotiation.

Question 19

Passico has two divisions, Amber division and Crimson division. Amber division, which has an annual capacity of 20,000 units, manufactures parts at a variable cost of $35 per unit, which sell on the market for $50 per unit. Market demand is currently 10,000 units per year. Crimson division requires 5,000 units per year from Amber division.

In a negotiation, what range would the transfer price fall in?

Question 20

Simpatronics has two divisions. Division A manufactures goods for a variable cost of $100 that could sell on the market for $150. Market demand is unlimited. Currently, Division A transfers their entire output to Division B, which saves Division B $15 per unit in purchasing costs.

In a negotiation, what range would the transfer price fall in?

Question 21

Doone, Inc. manufactures goods in Sigma division that cost $40 per unit plus fixed costs to manufacture. The goods have a market price of $85 per unit. Sigma division has a manufacturing capacity of 10,000 units, all of which are currently transferred to Epsilon division for use in the goods they manufacture. Epsilon division wants all of their parts to come from the same supplier, whether that is Sigma division or an outside supplier. Outside market demand is currently 6,000 units.

In a negotiation, what range would the transfer price fall in?

Determine whether the company would prefer a high or low transfer price.

Question 22

International Manufacturing has two divisions. Division A, which manufactures goods that are transferred to Division B, is located in Bulgaria, which has a corporate tax rate of 10%. Division B is located in the United States, where International falls into the 30% tax bracket.

Determine whether the company would prefer a high or a low transfer price.

Question 23

Pillsur Corporation manufactures parts in their Australia division, which is subject to a 30% tax rate. The parts are transferred to the Egypt division for assembly and sale. The tax rate in Egypt is 20%.

Determine whether the company would prefer a high or a low transfer price.

Complete Problems

Long-Run Pricing for External Customers

Question 24

Bedivere Manufacturing is trying to decide how much to charge for their new product, which has cost $5,000,000 for development and production setup. Annual fixed costs are not expected to increase as a result of the new product, but variable costs are expected to be $14 per unit. The product should sell an average of 10,000 units a year during its 10-year life. Bedivere plans to earn a profit margin of 30% on the product.

What price should be set for the product?

Question 25

Catoosa Company is hoping to launch a new product that will cost $70 in direct materials and $80 in direct labor per unit. Startup and development costs should total $18,000,000, and fixed costs will be $200,000 per year. Variable manufacturing overhead is estimated at 75% of direct labor costs. Catoosa plans to pay their salespeople a 10% commission on the product. Catoosa hopes to earn a markup of 15% on full costs. Sales are expected to be 30,000 units in the first year. Unit sales are expected to rise by 10,000 units per year for the next 5 years, then drop 20,000 a year for 3 years, at which point the product is expected to be obsolete.

What price should be set for the product?

Question 26

Wilster Corporation is pricing a product that they estimate will cost $600 per unit for direct materials and $350 per unit for direct labor. Manufacturing overhead is applied to products at a rate of 120% of direct labor costs. Sixty percent of manufacturing overhead is variable. The company’s regular fixed costs will not be affected by the new product, except for $1,000,000 in development costs and $7,000,000 in machinery. The product has an 8-year life. Sales should be 3,000 units in the first year, then should increase by 50% each year for 3 years before falling off by 20% each year for the last 4 years of its life. Wilster prices products to earn a 20% markup on full costs.

What price should be set for the product?

Question 27

Middleton Company is considering launching a new product, which will have a 12-year life once sales begin. Middleton estimates that demand will be 10,000 units the first year regardless of the price that is set. Demand is expected to increase by 1,000 units each year for the next three years, stay steady through year 8, then drop by 2,000 units each year until the end of its life. The product will require an investment of $1,200,000 in R&D costs, $2,000,000 in machinery and equipment, $500,000 in advertising costs, and $200,000 in administrative costs over the course of its life. Manufacturing costs for the product will be $60 per unit for direct materials, $70 per unit for direct labor, and $35 per unit for variable manufacturing overhead. Annual fixed costs will be $1,000,000.

What price should be set for the product?

Short-Run Pricing for External Customers

Question 28

CellCo wishes to liquidate their inventory of older cell phones. The phones cost $50 and sold for $120. CellCo will incur costs of $10 per phone to store them until they are sold and to advertise that they are on sale.

Calculate the minimum price per unit the company should accept.

Question 29

Ellipsis Manufacturing produces goods costing $12 per unit in variable costs and $20 per unit in fixed costs that sell for $45 each. Another firm has asked if Ellipsis will make a special production run to manufacture 3,000 units for them in a one-time-only special order. Ellipsis has the manufacturing capacity to fill the special order without giving up any regular sales.

Calculate the minimum price per unit that the company should accept.

Question 30

Fandango Enterprises produced 300 irregular units during the manufacturing process this month. The units cannot be sold through Fandango’s normal distribution channels. They each cost $45 in variable manufacturing costs to produce. Fandango could sell them through a deep discount retailer but would incur costs of $5 per unit for shipping.

Calculate the minimum price per unit that the company should accept from the retailer.

Question 31

Retail-o-Rama wants to liquidate its inventory of older computers. The computers cost $350 and sold for $800. Retail-o-Rama will incur costs of $25 per computer to store them until they are sold, and pay its salespeople $40 per computer to sell them.

Calculate the minimum price per unit that the company should accept.

Transfer Pricing

Question 32

The Papers division of Forsythe Industries manufactures cardboard, which they transfer to the Box division, who uses the cardboard to make boxes. Cardboard costs $0.02 per square foot to make (plus fixed costs, which are $30,000 per year for the Papers division) and sells for $0.05 per square foot on the market. The Box division uses 32 square feet to make a box, which costs an additional $0.10 per box to manufacture (plus fixed costs, which are $20,000 per year for the Box division). Boxes are sold for $2.50 each. The Papers division has the capacity to produce 2,000,000 square feet of cardboard a year, which is sufficient to fill the needs of both the Box division and the external market. The Box division sells 50,000 boxes per year. Both divisions are located in the same tax jurisdiction.

Calculate the transfer price if it is based on:

• Variable cost with a 10% markup
• Full cost with a 10% markup
• Market price

What range would the transfer price fall into if it were negotiated between the two divisions?

Would the company as a whole prefer a high or low transfer price?

Question 33

Bellway Company produces components in the Parts division, located in France, that cost $40 per component in variable costs and sell on the market for $60 per component. Market demand for the components is unlimited. Currently, Bellway transfers all 10,000 components they manufacture each year to the Assembly division, located in Florida, which uses two components in each of the 5,000 units they produce. The Assembly division could buy components on the open market, but they would incur purchasing costs of $5 per unit if they did so. In addition to the cost of the components, each unit costs $100 in variable costs and sells on the market for $300. Fixed costs are $100,000 for the Parts division and $350,000 for the Assembly division. The tax rate is 20% in Florida and 35% in France.

Calculate the transfer price if it is based on:

• Variable cost with a 10% markup
• Full cost with a 10% markup
• Market price

What range would the transfer price fall into if it were negotiated between the two divisions?

Would the company as a whole prefer a high or low transfer price?

Question 34

Constellation Corporation manufactures parts in Division A that are transferred to Division B for use in their product, which requires one part per unit. Costs are as follows:

Type	Division A	Division B
Variable	$30 per part	$80 per unit + cost of parts
Fixed	$400,000	$500,000

Division A has the capacity to produce 40,000 parts, which could sell on the market for $50 per part. Market demand is 30,000 parts. Division B has the capacity to produce 40,000 units, which could all sell on the market for $200 per unit. Division A operates in a jurisdiction with a 20% tax rate, and Division B operates in a jurisdiction with a 25% tax rate.

Calculate the transfer price if it is based on:

• Variable cost with a 20% markup
• Full cost with a 20% markup
• Market price

What range would the transfer price fall into if it were negotiated between the two divisions?

Would the company as a whole prefer a high or low transfer price?

Question 35

Blueberry Corporation has a packaging division in Dewia, a country with a tax rate of 25%. They also have a manufacturing division in Glewia, where the tax rate is 40%. Units manufactured in Glewia are shipped to Dewia for packaging and sale. The market price for the unpackaged product is $200, and it costs $75 per unit in variable costs per unit and $35,000 in fixed costs per year to manufacture. They have a market demand of 8,000 units and currently can produce 8,000 units. The packaging division incurs $15 per unit in variable costs in addition to the cost of acquiring the unpackaged product (whether from the manufacturing division or from an external supplier). They sell the packaged product to consumers for $350 per unit. If the packaging division could buy from the manufacturing division, they could reduce their annual fixed costs by $12,000.

Calculate the transfer price if it is based on:

• Variable cost with a 10% markup
• Full cost with a 20% markup
• Market price

What range would the transfer price fall into if it were negotiated between the two divisions?

Would the company as a whole prefer a high or low transfer price?

Assignment Problems

Note: Check figures are not provided for assignment problems so your instructor may use them for homework.

Question 36

Chester Corporation is launching a new product that is expected to cost $75 in direct materials, $50 in direct labor, and $100 in variable overhead per unit. Fixed costs associated with the product are expected to be $500,000 each year the product is sold, and development and setup costs are expected to be $3,000,000. Chester expects to sell an average of 15,000 units a year over the product’s 7-year life. Chester hopes to earn a profit of 10% of full costs.

What price should be set for the product?

Question 37

Barry Manufacturing produces goods costing $25 per unit in variable costs and $40 per unit in fixed costs that sell for $100 each. Silman Enterprises has requested that Barry manufacture 5,000 units for Silman in a one-time-only special order. Barry has the manufacturing capacity to fill the special order without giving up any regular sales.

Calculate the minimum price per unit that Barry Manufacturing should accept.

Question 38

Montevallo Manufacturing operates a division in Brazil that manufactures goods for $30 in variable costs per unit. All 20,000 units manufactured each year are transferred to the Chicago division, where they are packaged for an additional $10 per unit and sold on the market for $75 each. There is no market for the product when it is unpackaged. The fixed costs of the Brazil division are $200,000 per year, and the fixed costs of the Chicago division are $250,000 per year. The tax rate in Brazil is 20%, while in Chicago the company pays 30% in taxes.

Calculate the transfer price if it is based on:

• Variable cost with a 10% markup
• Full cost with a 10% markup

Given that there is no intermediate market for the transferred product, what difficulties would arise if the two divisions were to attempt to negotiate a transfer price?

Would the company as a whole prefer a high or low transfer price?

Challenge Problems

Question 39

Tepper Enterprises is planning a new product for which price and demand will be related to a certain degree, but there will be some flexibility in setting the price. For the first year, demand for each price level is as follows:

Price	Demand
$30 – $40	200,000
$40 – $50	150,000
$50 – $60	120,000

The second year, demand in each category will go up by 50%, and stay steady in the third and fourth years. In the fifth year, demand in each category will go down to the original levels, and in the sixth through tenth years, it will decrease by 10,000 per year. Tepper expects that variable costs will be $30 per unit, and that fixed costs will be $750,000 per year. Tepper hopes to earn a profit of 30% of full costs.

What price should be set for the product?

Question 40

McGhee Manufacturing has just made a product modification and wishes to liquidate their inventory of 2,000 units of the old version of the product, which will become obsolete as soon as the new product hits the market. McGhee markets all products on the Internet. Advertising the sale on the old product will cost $12,000. McGhee would incur a cost of $5 per unit to dispose of the product if it is not sold. McGhee would incur a cost of $10 per unit to ship the product. Manufacturing costs were $40 per unit in variable costs and $15 per unit in fixed costs. The product normally sells for $80 per unit. The customer pays the price of the product plus shipping charges.

What is the minimum price that McGhee should charge for the product?

Question 41

Gallico has historically purchased all parts for their products (each unit requires two parts) from Roberts Corporation, and is considering acquiring Roberts in order to save money. As part of the acquisition, Gallico would agree to let the Parts division (Roberts Corporation) operate as independently as possible, and thus would allow the Parts division to negotiate a transfer price for the parts with the Manufacturing division. The Parts division would pay a tax rate of 25%, while the Manufacturing division would pay a tax rate of 30%. Information about the two potential divisions follows:

	Parts	Manufacturing
Annual manufacturing capacity	100,000	20,000
Annual outside market demand	80,000	35,000
Annual fixed costs	$1,300,000	$1,000,000
Variable cost per unit	$20*	$75 plus parts
Market selling price	$50	$250

*Includes $5 per unit in selling costs that could be avoided if the product is transferred internally.

1. What range will the negotiated price fall in?
2. What price from that range would Gallico most prefer?
3. Would it be worthwhile for Gallico to acquire Roberts? If so, what would the additional before-tax annual profit be, assuming that a transfer price can be negotiated between the two divisions?

Pre-Assessment Problems

Use these problems to check whether you are fully prepared for the assessment. Work the problems under assessment conditions – don’t use any notes or other materials!

Question 42

SellCo is hoping to launch a new product that will cost $5 in direct materials and $10 in direct labor per unit to manufacture. Variable overhead is applied to products at a rate of 120% of direct labor costs. SellCo plans to pay its salespeople a 10% commission on the product. Fixed costs will be $250,000 per year. SellCo estimates that the product will cost $15,000,000 to develop. Demand for the product is expected to be 40,000 in the first year. For the next six years after that, demand is expected to rise by 5,000 units per year. Then, for the next three years, demand is expected to drop by 20,000 per year, after which the product is expected to become obsolete.

• Assume SellCo wishes to earn a 20% profit margin. What price should be set for the product?
• Assume SellCo wishes to earn a 20% markup on full costs. What price should be set for the product?

Question 43

Variety Village produces goods costing $15 per unit in variable costs and $10 per unit in fixed costs to produce. The goods ordinarily sell for $50 each. Another firm has asked if Variety Village will make a special production run to manufacturing 1,000 units for them in a one-time-only special order. Variety Village has the manufacturing capacity to fill the special order without giving up any regular sales.

Calculate the minimum price per unit that the company should accept.

Question 44

Vivataxon, Inc. manufactures parts in Shionga, a country with a tax rate of 35%. Those parts are essential components for the electronic components manufactured in another division, located in Uswary, where the tax rate is 30%. The Shionga division currently has a capacity of 10,000 units, all of which the Uswary division needs for goods. They could sell up to 4,000 units on the open market as well; the current market price for the parts is $15 per unit. Variable costs are $7 per unit for the Shionga division, and $5 per unit for the Uswary division (in addition to the cost of the parts). Fixed costs are $40,000 for the Shionga division and $50,000 for the Uswary division. The Uswary division sells its electronic components for $30 per unit.

Calculate the transfer price if it is based on:

• Variable costs with a 15% markup
• Full costs with a 15% markup
• Market price
• What range would the transfer price fall into if it were negotiated between the two divisions?
• Would the company as a whole prefer a high or low transfer price?