Question 5 – Transfer Price
Division A, which is part of the ACF Group, manufactures only one type of product, a Bit, which it sells to external customers and also to division C, another member of the group. ACF Group's policy is that divisions have the freedom to set transfer prices and choose their suppliers.
The ACF Group uses residual income (RI) to assess divisional performance and each year it sets each division a target RI. The group's cost of capital is 12% a year.
Budgeted information for the coming year is as follows.
External selling price
$35 per Bit
$22 per Bit
Target residual income
Division C has found two other companies willing to supply Bits. X could supply at $28 per Bit, but only for annual orders in excess of 50,000 Bits. Z could supply at $33 per Bit for any quantity ordered.
Division C provisionally requests a quotation for 60,000 Bits from division A for the coming year. (i)
Calculate the transfer price per Bit that division A should quote in order to meet its annual profit target of $564,000.
(5 marks) (ii)
Calculate the two prices division A would have to quote to division C, if it became group policy to quote transfer prices based on opportunity costs.
Evaluate and discuss the impact of the group's current and proposed polices on the profits of divisions A and C, and on group profit. Illustrate your answer with calculations.
(16 marks) (Note: Ignore taxation)
(Total 25 marks)
Annual profit = external sales revenue + internal sales revenue – variable costs – fixed costs Therefore, $564,000 = ((150,000 – 60,000) × $35) + (60,000 × P) – (150,000 × $22) – $1,080,000, where P = transfer price.
Therefore P = $29.90
External sales demand is 110,000 units. Maximum capacity is 150,000 units and...
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