AA and BB are two divisions of the ZZ Group. The AA division manufactures electrical components, which it sells to other divisions and external customers. 

The BB division has designed a new product, Product B, and has asked AA to supply the electrical component, Component A, that is needed in the new product. This will be a completely new style of component. Each unit of Product B will require one Component A. This component will not be sold by AA to external customers. AA has quoted a transfer price to BB of £45 for each unit of Component A. 

It is the policy of the ZZ Group to reward managers based on their individual division’s return on capital employed. 

Details of the monthly production for each division are as follows:

Required 

1. Calculate, based on a transfer price of £45 per Component A, the monthly profit that would be earned as a result of selling Product B by: 

a. BB division 

b. AA division 

c. ZZ Group. 

2. Calculate the maximum monthly profit from the sale of Product B for the ZZ Group. 

3. Calculate, using the marginal cost of Component A as the transfer price, the monthly profit that would be earned as a result of selling Product B by: a BB division b AA division c ZZ Group. 

4. Discuss, using the above scenario, the problems of setting a transfer price and suggest a transfer-pricing policy that would help the ZZ Group to overcome the transfer-pricing problems that it faces.

Transcribed Image Text:

AA division Output Component A will be produced in batches of 1000 units. The maximum capacity is 6000 components per month. £15 per component £50 000 (these are incurred specifically to produce Component A) Variable cost Fixed costs BB division Product B will be produced in batches of 1000 units. The maximum customer demand is 6000 units of Product B per month. £9 per unit plus the cost of Component A £75 000 (these are incurred specifically to produce Product B) Output Variable cost Fixed costs The relationship between monthly customer demand and the selling price of Product B is shown below: Demand Selling price per unit 1000 units £120 2000 units £110 3000 units £100 4000 units £90 5000 units £80 6000 units £67