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5/26/2018 Transfer pricing alternatives for Prysm
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PERFORMANCE MANAGEMENT AN
CONTROL
GROUP ASSIGNMENTTHE PRYSM GROUP A TRANSFER
PRICING ISSUE
MBA 39 @ SDA Bocconi School of Management, Blue Class -
Y. Tian, H. Yadav, M. Ross i, G. Perezcasas, G. Sivakumar
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Agenda2
1. Problem identification
2. Framework of the alternatives
3. Sourcing decision impact on the three divisions
4. Solution
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The Submarine division of Prysm Group solicited bids for the furniture of the electroneeded to produce a new cable system, named X73. The quotes were asked to an
(the Systems division) and two external suppliers (Flying Dutchman and Control Tech
The choice of the supplier and the transfer pricing alternatives in case of internal pro
different levels of profitability for the Group overall and for the three divisions involved
1. Problem identification
Cables
division
Systems
division
Submarin
e
division
Flying
Dutchman
Control
Tech.
3
componentsElectr.
controlsX73 cable
Electr.
controls
Electr.
controls
Internal production
External production
140,000
1
20,5
00
1
00,5
00
340,000
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Agenda4
1. Problem identification
2. Framework of the alternatives
3. Sourcing decision impact on the three divisions
4. Solution
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2. Framework
We have considered the impact of the different opportunities available to the Prysm
to produce the new X73 cable system. We have also proposed some alternatives o
of internal production of the electronic components, that can be summarized as follow
Production of
X73 cable
Internally
At actual TP
policy price
At Market-
based
TP
At full-cost
TP
At Variable
cost
TP
At cost plus
2%
TP
From F
Dutchm
5
Transfer pricing alternatives
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Agenda6
1. Problem identification
2. Framework of the alternatives
3. Sourcing decision impact on the three divisions
4. Solution
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.impacton the three divisions
Analysis of the best sourcing decision for the X73 materials for:
a. The Submarine Division
b. The Systems Division
c. The Cables Division
d. Prysm Group
7
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a. The Submarine division8
INTERNAL PRODUCTION: On the basis of actual transfer pricing policies, the Submarine division is exp
All the other policies would permit to this division to sell at profit.
Obviously the most advantageous option for this division is the Variable cost policy. The full cost met
margin to that gettable from the cheapest external supplier, while with the cost plus 2% method, the
lower.
EXTERNAL PRODUCTION: Among the two alternatives, the offer received by Flying Dutchman would b
SUBMARINE DIVISION
INTERAL PRODUCTION
AT ACTUAL
TRANSFER PRICING
POLICY
MARKET-BASED COST PLUS 2% FULL COST VARIABLE COSTF
FLYING D
Revenues (expected) 340.000,00 340.000,00 340.000,00 340.000,00 340.000,00 34
Cost of other components -72.000,00 -72.000,00 -72.000,00 -72.000,00 -72.000,00 -72
Variable conversion costs -26.300,00 -26.300,00 -26.300,00 -26.300,00 -26.300,00 -26
Cost of electronic control:
- Internal supplier -140.000,00 -110.500,00 -103.795,20 -101.400,00 -37.400,00
- Flying Dutchman -10
- Control Technologies
Contribution margin 101.700,00 131.200,00 137.904,80 140.300,00 204.300,00 14
Fixed conversion costs -117.700,00 -117.700,00 -117.700,00 -117.700,00 -117.700,00 -11
EBIT -16.000,00 13.500,00 20.204,80 22.600,00 86.600,00 23ROS (expected) -5% 4% 6% 7% 25%
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b. The System division9
INTERNAL PRODUCTION: On the basis of actual transfer pricing policies (sale at market price), th
generate a return on sales of 25%.
Considering that it is pricing at a above-average margin and In order to be more competitive, it cou
market-based policy, still making a margin of 7%. If this were not sufficient it could sell at cost plus 2%
to maintain the break-even. As a last resort, the System division could reduce the price even more: the
internal production not convenient anymore is Eur 37,400 (equal to the Variable COGS, that would mak
equal to 0).
EXTERNAL PRODUCTION: Due to the cost structure of the department, characterized by Eur 55,000 oproduction would imply a loss for the System division equal to the aforementioned fixed costs.
SYSTEM DIVISION
INTERAL PRODUCTION
ACTUAL:
PRICE TO THE MARKETMARKET-BASED COST PLUS 2% FULL COST VARIABLE C
Revenues 140.000,00 110.500,00 103.795,20 101.400,00 37.400,
Var. COGS:
- From Cables division -21.600,00 -19.800,00 -18.360,00 -18.000,00 -9.000,0
- Others -28.400,00 -28.400,00 -28.400,00 -28.400,00 -28.400,
Contribution margin 90.000,00 62.300,00 57.035,20 55.000,00 -
Fixed COGS -55.000,00 -55.000,00 -55.000,00 -55.000,00 -55.000,
EBIT 35.000,00 7.300,00 2.035,20 - -55.000,
ROS 25% 7% 2% BREAK-EVEN
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c. The Cable division10
INTERNAL PRODUCTION: On the basis of actual transfer pricing policies (sale at cost plus 20%), generate a return on sales of 17%.
In order to be make the System division more competitive towards the Submarine one, it could acc
based policy or even at cost plus 2% margin. The price of Eur 18,000 would then be the minimum to ge
The minimum price at which the Cable division could sell is Eur 9,000 (equal to the Variable COG
Contribution margin equal to 0).
EXTERNAL PRODUCTION: Due to the cost structure of the department, characterized by Eur 9,000 o
production would imply a loss for the Cable division equal to the aforementioned fixed costs.
CABLE DIVISION
INTERAL PRODUCTION
ACTUAL:
COST PLUS 20%MARKET-BASED COST PLUS 2% FULL COST VARIABLE C
Revenues 21.600,00 19.800,00 18.360,00 18.000,00 9.000,0
Var. COGS -9.000,00 -9.000,00 -9.000,00 -9.000,00 -9.000,0
Contribution margin 12.600,00 10.800,00 9.360,00 9.000,00 -
Fixed COGS -9.000,00 -9.000,00 -9.000,00 -9.000,00 -9.000,0
EBIT 3.600,00 1.800,00 360,00 - -9.000,0
ROS 17% 9% 2% BREAK-EVEN
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d. Prysm Group11
INTERNAL PRODUCTION: On the basis of actual transfer pricing policies, the Group overall is expecte
sales of 7% with a EBIT of Eur 22,600. It would not be convenient for the Submarine division only.
Of course, the different transfer pricing policies that we have hypothesized, would determine differen
divisions.
EXTERNAL PRODUCTION: Even if more convenient for the Submarine division, the externaliza
expected to determine a loss for the Group overall with both the suppliers, due to the weight of the f
total) of the other two divisions.
GROUP OVERALL
INTERAL PRODUCTION
AT ACTUAL
TRANSFER PRICING
POLICY
MARKET-BASED COST PLUS 2% FULL COST VARIABLE COSTF
FLYING D
EBIT of System div. 35.000,00 7.300,00 2.035,20 - -55.000,00 -55
EBIT of Cable div. 3.600,00 1.800,00 360,00 - -9.000,00 -9
EBIT of Sub. div. (expect.) -16.000,00 13.500,00 20.204,80 22.600,00 86.600,00 2
Goup EBIT (expected) 22.600,00 22.600,00 22.600,00 22.600,00 22.600,00 -40
Group ROS (expected) 7% 7% 7% 7% 7% -
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Agenda12
1. Problem identification
2. Framework of the alternatives
3. Sourcing decision impact on the three divisions
4. Solution
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4. Solution
a. Identification of the best transfer price
a. Solution proposed to Mr. Zubini
13
Id tifi ti f
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a. Identification ofthe best transfer price
The actual TP method cannot be adopted, since the CP that finally sells to the ouwould incur a loss and therefore would not accept at all the internal production.
In order to avoid a loss for the Group overall, a better policy should therefore be ado
On the basis of the information available, a market-based transfer pricing would
solution, because the cables market is not well-defined, affected by specialpricin
therefore it is not easy to predict what could be the market price to adopt.
Looking at cost-based methods, in order to motivate the Submarine division to
internal production, the transfer price could be set equal to variable cost. The ma
policy is that without adding a lump-sum covering the supplying divisionsrelated fi
would not get any advantage.
With a full-cost method the Systems and Cables division would at least reach the
they would still make no margin and in case of limitation of the capacity they c
anymore to produce for the internal customer.
Finally, a cost plus method would permit to all the divisions to have a positive return
14
b S l ti d
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b. Solution proposedto Mr. Zubini
Following our analysis, we recommend to Prysm a cost plus-based transfer pricinThis solution would permit the Submarine division to consider the internal produ
opportunity, being also competitive under a pure economical standpoint. The oth
would still have advantage, since not only they will offset their cost, but they will mak
We propose Mr. Zubini to give us more time and information in order to investigate a
percentage of mark-up to adopt for the Systems and Cables division. The am
determined by taking into consideration the market price of the products of the standard mark-up charged by the competitors to their clients and standard mark-up
two divisions when serving external customers. Eventually two different percenta
could be adopted for the two divisions.
A delicate aspect to be taken into consideration is the available margin of cap
divisions, in case of growth of their external demand or in case of growth of the
cables.
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