Pagesky Armour Industries Manufactures High-Grade Aluminum ✓ Solved

4 Pagessky Armour Industries Manufactures High Grade Aluminum Luggage

Sky Armour Industries manufactures high-grade aluminum luggage made from recycled metal. The company operates two divisions: metal recycling and luggage fabrication. Each division operates as a decentralized entity. The metal recycling division is free to sell sheet aluminum to outside buyers, and the luggage fabrication division is free to purchase recycled sheet aluminum from other sources. Currently, however, the recycling division sells all of its output to the fabrication division, and the fabrication division does not purchase materials from any outside suppliers.

Aluminum is transferred from the recycling division to the fabrication division at 110% of full cost. The recycling division purchases recyclable aluminum for $0.50 per pound. The division’s other variable costs equal $2.80 per pound, and fixed costs at a monthly production level of 50,000 pounds are $1.50 per pound. During the most recent month, 50,000 pounds of aluminum were transferred between the two divisions.

The recycling division’s capacity is 70,000 pounds. Due to increased demand, the fabrication division expects to use 60,000 pounds of aluminum next month. Metalife Corporation has offered to sell 10,000 pounds of recycled aluminum next month to the fabrication division for $5.00 per pound. Calculate the transfer price during the most recent month per pound of recycled aluminum. Assuming that each division is considered a profit center, would the fabrication manager choose to purchase 10,000 pounds next month from Metalife? Is the purchase in the best interest of Sky Armour Industries? Show your calculations. What is the cause of this goal incongruence? The fabrication division manager suggests that $5.00 is now the market price for recycled sheet aluminum and that this should be the new transfer price. Sky Armour Industries’ corporate management tends to agree.

The metal recycling manager is suspicious. Metalife’s prices have always been considerably higher than $5.00 per pound. Why the sudden price cut? After further investigation by the recycling division manager, it is revealed that the $5.00 per pound price was a one-time-only offer made to the fabrication division due to excess inventory at Metalife. Future orders would be priced at $5.50 per pound. Elaborate on the validity of the $5.00 per pound market price and the ethics of the fabrication manager. Would changing the transfer price to $5.00 matter to Sky Armour Industries?

Sample Paper For Above instruction

Introduction

Sky Armour Industries exemplifies a modular corporate structure, segmented into two operational divisions: metal recycling and luggage fabrication. Such a structure necessitates the establishment of transfer prices to facilitate intra-company transactions. The central question revolves around determining an appropriate transfer price that aligns with the divisions' profit centers while considering external market influences. This analysis explores the calculation of the transfer price during the recent month, evaluates managerial decisions on purchasing external aluminum, and examines the ethical and strategic implications of the proposed market-based transfer price, especially in the context of a sudden price cut by Metalife Corporation.

Calculation of the Transfer Price for the Most Recent Month

The transfer price calculation begins with understanding the costs incurred by the recycling division. The division’s total variable costs per pound are $0.50 (purchase cost) plus $2.80 (variable costs), totaling $3.30. Fixed costs amount to $1.50 per pound, but these are sunk costs and do not influence the marginal cost of transfer—especially since the division operates at full capacity, producing 50,000 pounds. Since all output is transferred internally at 110% of full cost, initial full cost per pound is:

• Full cost per pound = variable costs + fixed costs = $3.30 + $1.50 = $4.80

Thus, the transfer price during the most recent month was:

• Transfer price = 110% of full cost = 1.10 × $4.80 = $5.28 per pound

This reflects the internal transfer cost for aluminum during this period, based on the company's internal policy.

Decisions of the Fabrication Division: Buying External Aluminum

Since the market offers aluminum at $5.00 per pound through Metalife, and the internal transfer cost is $5.28 per pound, the fabrication division faces a decision: purchase externally at $5.00 or internally at $5.28. Rational decision-making under profit center accountability suggests the division would prefer to buy from Metalife at $5.00, as this is cheaper than the internal transfer price.

However, if Sky Armour Industries explicitly sets internal transfer prices to surpass external market prices, the divisional managers may be disincentivized to maximize overall profitability, leading to inefficiencies. Moreover, purchasing externally at $5.00 per pound would reduce the internal transfer volume, which might negatively impact the recycling division’s revenue.

Implications for Sky Armour Industries

From the company's perspective, the decision to accept external purchase at $5.00 per pound, given a transfer price of $5.28, could reduce internal revenues and distort profit measurements for each division. Since divisions are assessed separately, profit centers face an incentive to source externally when external prices are lower, which may not align with overall corporate objectives.

Within this framework, the goal incongruence arises from the transfer pricing policy that emphasizes cost recovery plus markup without regard to external market prices, thereby potentially discouraging optimal resource allocation.

The Ethical and Practical Dimensions of the Market Price and the Unexpected Price Cut

The fabrication division manager argues that $5.00 per pound is the current market price, whereas the recycling manager suspects that this is an artificially low, one-time offer. Metalife’s typical pricing exceeds $5.00, around $5.50 per pound, which aligns with long-term market trends.

The ethical dilemma centers on whether the fabrication division manager should accept a below-market transfer price, possibly to benefit the division at the expense of the company. Accepting a one-time special price might undermine transparent pricing negotiations and distort financial reporting.

The sudden price cut at $5.00 was due to excess inventory, not reflecting the true market conditions. While this offers an immediate cost advantage, relying on such temporary prices could harm long-term strategic relationships and may foster unethical behavior if managers attempt to exploit temporary market dips.

Strategic and Managerial Implications

Changing the transfer price to $5.00 could influence division behavior, potentially encouraging internal transactions at artificially low prices. If the company adopts this as a standard rate, it might distort performance assessments and managerial incentives.

Furthermore, adopting a market-based transfer price aligned with the $5.50 rate would promote transparency and performance consistency, ensuring internal decisions reflect true external conditions.

Conclusion

In conclusion, the appropriate transfer price during the most recent month was approximately $5.28 per pound, based on internal cost calculations with markup. The decision of the fabrication division to purchase externally at $5.00 benefits its profitability but may undermine internal revenue flows and overall strategic coherence. The ethical issues surrounding the temporary price cut involve balancing short-term gains against long-term integrity and transparency. Sky Armour Industries would benefit from establishing a transfer pricing strategy that reflects authentic market conditions, promoting both ethical standards and operational efficiency.

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