Parkside Inc.has several divisions that operate as decentralized profit centers.Parkside's Entertainment Division manufactures video arcade equipment using the products of two of Parkside's other divisions.The Plastics Division manufactures plastic components,one type that is made exclusively for the Entertainment Division,while other less complex components are sold to outside markets.The products of the Video Cards Division are sold in a competitive market;however,one video card model is also used by the Entertainment Division.The actual costs per unit used by the Entertainment Division follow: (CMA adapted) The Plastics Division sells its commercial products at full cost plus a 25% markup and believes the proprietary plastic component made for the Entertainment Division would sell for $6.25 per unit on the open market.The market price of the video card used by the Entertainment Division is $10.98 per unit.Assume that the Plastics Division has excess capacity and it has negotiated a transfer price of $5.60 per plastic component with the Entertainment Division.This price will:

Question

Parkside Inc.has several divisions that operate as decentralized profit centers.Parkside's Entertainment Division manufactures video arcade equipment using the products of two of Parkside's other divisions.The Plastics Division manufactures plastic components,one type that is made exclusively for the Entertainment Division,while other less complex components are sold to outside markets.The products of the Video Cards Division are sold in a competitive market;however,one video card model is also used by the Entertainment Division.The actual costs per unit used by the Entertainment Division follow: (CMA adapted)  The Plastics Division sells its commercial products at full cost plus a 25% markup and believes the proprietary plastic component made for the Entertainment Division would sell for $6.25 per unit on the open market.The market price of the video card used by the Entertainment Division is $10.98 per unit.Assume that the Plastics Division has excess capacity and it has negotiated a transfer price of $5.60 per plastic component with the Entertainment Division.This price will:

Quizplus · Accepted Answer

The negotiated transfer price of $5.60 per plastic component is lower than the estimated sale price of $6.25 per unit on the open market. This means that the Entertainment Division is getting the component at a lower price, which will increase its profitability. The Plastics Division will also benefit from selling its excess capacity, and will have an incentive to continue producing the proprietary plastic component. As estimated profits will be shared, both divisions will be motivated to perform well. Therefore, the transfer price will motivate both divisions and is a win-win situation.