1. Team Exercise Transfer price: A transfer price is what one part of a company charges another part of the company for a good or service.

2. You are organized into teams of two, and each team is matched with two other teams (to form “super” teams of six). Choose a team leader. The team leader is responsible for picking up, distributing, collecting, and returning the index cards; and also for handing in the one-page write-up at the end of class. (A great honor indeed; leadership has its rewards)

3. The index cards consist of FOUR separate scenarios. Each scenario is printed on a different color index card: green, red, yellow and blue. The team leader should hand out the red cards to one team, the yellow cards to another team, and retain the green and blue cards for his/her own team.

4. Each scenario is played one at a time, starting with scenario 1 (green), and proceeding through scenario 4. To play each scenario, do the following: The team with the cards for that scenario should retain the card that says “top management”, give the “buyer” card to one team, and the “seller” card to the other team. Every team should get to play buyer and seller at least once.

5. The buyer team and seller team first talk among themselves to devise a strategy for the negotiations. Each division wants a favorable transfer price, to maximize divisional profits. Then the buyer team and seller team negotiate a transfer price. Top management has all of the information from both sides. It is your job to intervene in the negotiations only if it becomes clear that the two divisions are not going to reach an agreement. In this event, you should terminate the negotiations and move on to the next scenario.

6. Top management also must record the outcome on the one-page summary that will be handed in at the end of class. REMEMBER: –Play one scenario at a time; finish it, and go on to the next scenario. –Top management should not share information with either division either before or during negotiations. –Before negotiations, each team must determine privately its strategy for negotiating. No eaves- dropping by the other division. –Every team gets to be the buyer at least once.

7. Scenario 1 (Green) Seller: Capacity 150,000 units Demand 120,000 units External Price $14.00 Regular Variable Cost $9.00 Cost savings on internal order $1.00 Buyer: Requirements 12,000 units Market price $14.00

8. Scenario 1 (Green) Seller: Excess capacity? YES Will be willing to accept a transfer as low as $8.00 (regular variable cost of $9 less savings of $1) Buyer: Will be willing to pay up to $14, but no more, since you can buy externally for $14.

9. Scenario 2 (Red) Seller: Capacity 150,000 units Demand 150,000 units External Price $15.00 Regular Variable Cost $9.00 Cost savings on internal order $2.00 Buyer: Requirements 12,000 units Market price $14.00

10. Scenario 2 (Red) Seller: Excess capacity? NO Opportunity cost: lost contribution margin on each external sale $15.00 - $9.00 = $6.00 To make at least $6.00 contribution margin on an internal sale, the transfer price must be at least ($9 - $2) + $6 = $13. Buyer: Will be willing to pay up to $14, but no more, since you can buy externally for $14.

11. Scenario 3 (Yellow) Seller: Capacity 150,000 units Demand 150,000 units External Price $15.00 Regular Variable Cost $9.00 Cost savings on internal order none Buyer: Requirements 12,000 units Market price $14.00

12. Scenario 3 (Yellow) Seller: Excess capacity? NO Opportunity cost: lost contribution margin on each external sale $15.00 - $9.00 = $6.00 To make at least $6.00 contribution margin on an internal sale, the transfer price must be at least $9.00 + $6.00 = $15.00. Buyer: Will be willing to pay up to $14, but no more, since you can buy externally for $14.

13. Scenario 4 (Blue) Seller: Capacity 150,000 units Current Sales: 120,000 units externally at $14 12,000 units internally at $13 Regular Variable Cost $9.00 (no cost savings on the internal orders) Buyer: You have received an offer to sell additional product at $20. Variable cost is the cost of the intermediate component plus $9.

14. Scenario 4 (Blue) Seller: Excess Capacity YES Variable cost is $9. You should be willing to accept a transfer price as low as $9. Buyer: You are willing to pay up to $11 for the inter- mediate product for these additional sales: $20 selling price less $9 additional mfg cost = $11.

15. Please turn in the cards, sorted and paper-clipped as they were handed out (Scenario 1 on top, then 2, 3 and 4; within each scenario, top management on top, then buyer, then seller. Please turn in the one page write- up.