Question: “U.S Pump Systems”

US Pump is a multi divisional firm that manufactures and installs chemical piping and pump systems. The valve division makes a single standardized valve. The valve division and the installation division are currently involved in a transfer pricing dispute. Last year half of the valve divisions output was sold to the installation division for $40 and the remaining half was sold to outsiders for $60.

The existing transfer price has been set at $40 per pump through a process of negotiation between the two divisions with the involvement of senior management. The installation division has received a bid from an outside valve manufacturer to supply it with an equivalent valve for $35 each.

The manager of the valve division has argued that if it is forced to meet the external price of $35, it will lose money on selling internally.

TO INSTALLATION DIVISION TO OUTSIDE

Sales 20,000@$40 $800,000 20,000@$60 $120,000

Variable Costs 20,000@$30 (600,000) (600,000)

Allocated Fixed Costs (135,000) (135,000)

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Gross Margin $65,000 $465,000

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Analyze the situation and recommend a course of action. What should installation division managers do? What should valve division managers do? What should U.S. Pump’s senior managers do?