transfer pricing alternatives for prysm

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


3/15

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


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




4. Solution


5/15

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




4. Solution


7/15

.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




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.

15

transfer pricing alternatives for prysm

Documents

prysm 215agenda21

prysm 615agenda61

prysm 415agenda41

cost metmargin

cost of electronic control

variable cost policy

sourcing decision impact

problem identification2