Based on the given case facts (See Appendix), hereunder are the effects of each alternative pricing. Quantitative Effects of Alternative Transfer Prices on the ROI of Reading Company: Reading Co.’s Offer = $ 11.80 Millwall Co.’s Offer = $7.68 VP Finance Offer = $10.12 Selling Price $ 11.80 Mftg. VC+FC ( 8.40) Gross Profit $ 3.40 S & A 0.00 NIBT $ 3.40 % NIBT./Capital = 40.48% Standard with Normal Operations = 30% Selling Price = $ 7.68 Mftg VC + FC = ( 8.40) Loss = ($0.72) S & A 0 Net Loss ($0.72) % Net Loss/Capital(8.57%) Selling Price = $10.12 Mftg.VC + FC = ( 8.40) Gross Profit = $1.72 S & A 0 NIBT =$1.72 %NIBT/Capital =20.48% Since the effects of Millwall Company’s buying price offer and the ACS Corporate VP Finance recommended buying price offer would certainly pull down the ROI of Reading Company, it will definitely be unfair for the provider of component. On the other hand, the offer of Reading Company seeks to take advantage of the situation of Millwall Company by demanding a price that will give Reading Company a much higher Return on Capital Invested before tax for the component orders of Millwall Company. The usual ROI before tax of Reading Co. is only 30%. And Reading wants 40% NIBT/Capital. The effect of selling at the price of Millwall’s proposal will certainly create management protest against dragging the performance of Reading down by an act of Millwall Co. management. Reading Co. management should have been consulted about the bidding cost for the component before the wrong cost was quoted. Apparently, the buying price offer of Millwall would make Reading Co. incur a loss per component amounting to ($ 0.72). Granted that the fixed cost will nonetheless be incurred whether or not there is an order from Millwall, Reading Co. management can reasonably argue that their practice is to assign each component the value of $ 2.40 fixed manufacturing cost. There was also a mistake on the part of Reading Co. when its management gave the variable cost information to Millwall Co., because the figure given should have been the total manufacturing cost, since the fixed manufacturing cost was also dependent on the number of units produced. Thus, Reading Co. caused Millwall Co. to make a mistake in the bidding. Immediate Solution for the Transfer Pricing Problem of Reading Co.& Millwall Co. The management of Reading Co. should realize the mistake of communicating to Millwall Co. a variable cost value intended for bidding. Clarifications should have been made prior to disclosing such a low variable cost, if it cannot be a basis for Transfer Pricing, Reading Co. should agree with the policy of not over pricing and limiting its profitability on the potential orders of Millwall to a maximum equivalent to what it is currently earning. That is 30%. Furthermore, since it disclosed that its variable cost is $7.60, Reading Co. management should compute its Transfer Price based on what they had communicated. For example, Transfer Price = X ; Mftg. VC = $ 7.60 ; therefore X - 7.60 = 30% of X. X – 30%X = 7.60 ; 70%X = 7.60 ; X = 7.6 / 0.7 = $ 10.85 should be the maximum price By asking for the maintenance of its profitability in terms of Returns on Capital Invested, the management of Reading Co. can be considered in good faith. That is, the management did not fool Millwall Co.. Millwall Co. management should also realize the mistake of submitting a bid not based on a negotiated Transfer Price of component coming from a subsidiary. The Transfer Price should have been finalized before quoting a price in the bidding. In the case wherein a bid was won based on wrong information, the problem will have to be escalated
A problem involving Transfer Pricing has occurred between two subsidiaries of ACS at a time when there was no set of corporate policies for management decision making guidelines. …
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