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Transfer Pricing: Govind S. Iyer
Transfer Pricing: Govind S. Iyer
Govind S. Iyer
Transfer Pricing
Transfer price is the price one segment charges, for a product or service supplied to, another segment. The primary purpose of transfer pricing is to motivate managers to act in congruence with the objectives of the firm as a whole.
Transfer Pricing
Three major decisions must be made in any transfer price situation
Sourcing: Should segments be free to decide whether to sell/buy from other segments? Transfer price: What price should be set for any transfer? Intervention Policy: When should HQ mediate to resolve disputes between divisions?
Transfer-Pricing Example
Two divisions S (seller) and B (buyer) S has a capacity of 100,000 units to make product G Out of pocket costs are $20 per unit of G S is producing at full capacity and can sell all that it can produce in the outside market for $50
Transfer-Pricing Example
If B wants to buy G from S what is the minimum price at which S should sell? It is $20 out of pocket costs plus $30 opportunity costs The minimum transfer price S should accept is $50 per unit of G
Transfer-Pricing Example
B has two options It can combine one unit of G with one unit of H (bought from an outside vendor for $30), spend $10 on labor and make one unit of K which it can then sell in the outside market for $125 Alternatively, B can make and sell L for a profit of $25 per unit B can make either 100,000 units of K or L
Prepared for Instituto de Empresa
Transfer-Pricing Example
If B wants to buy G from S what is the maximum price that B should be willing to pay? Incremental value from transfer is (125-3010) = $85 Opportunity costs for B = $25 (lost profit from L) Maximum price that B would pay for one unit of G = $85-$25 = $60
Prepared for Instituto de Empresa
Transfer-Pricing Example
B is willing to pay a maximum of $60 S expects a minimum of $50 Do you think the negotiations between B and S will lead to an agreement for transfer of G from S to B? Is this transfer decision optimal from the parent companys perspective?
Transfer-Pricing Example
What if B can sell L for a profit of $50? Will transfer of G take place? What is the right thing for S to do? For B? Are these decisions, wealth-maximizing from the companys point of view?