Engcorp and Flotilla are UK divisions of Griffin plc, a multinational company. Both divisions have a wide range of activities. You are an accountant employed by Griffin plc and the Finance Director has asked you to investigate a transfer pricing problem.
Engcorp makes an engine, the Z80, which it has bee selling to external customers at £1350 per unit. Flotilla wanted to buy Z80 engines to use in its own production of dories; each dory requires one engine. Engcorp would only sell if Flotilla paid £1350 per unit. The managing director of Engcorp commented:
'We have developed a good market for this engine and £1350 is the current market price. Just because Flotilla is not efficient enough to make a profit is no reason for us to give a subsidy.' Flotilla has now found that engines suitable for its purpose can be bought for £1300 per unit from another manufacturer. Flotilla is preparing to buy engines from this source.
From information supplied by the divisions you have derived the following production and revenue schedules which are applicable over the capacity range of the two divisions:

(a) Ignoring the possibility that Flotilla could buy engines from another manufacturer, calculate to the nearest 100 units:
(i) The quantity of Z80 production that would maximize profits for Griffin plc, and
(ii) The consequent quantity of Z80 units that would be sold to external customers and the quantity that would be transferred to Flotilla. (8 marks)
(b) Explain the issues raised by the problems of transfer pricing between Engcorp and Flotilla, and discuss the advantages and disadvantages of the courses of action which could be taken.
(c) Discuss the major considerations in setting transfer prices for a profit-maximizing international group.

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Engcorp's data for Z80 engines Flotilla's data for dories Total Total cost of Total revenue producing revenue dories Total from from Annual manufactuing outside excluding sales of number of units cost sales engine costs dories (£000) (£000) (£000) (£000) 100 200 300 400 500 600 700 800 115 185 261 344 435 535 645 766 204 362 486 598 703 803 898 988 570 1120 1670 2220 2770 3320 3870 4420 703 1375 2036 2676 3305 3923 4530 5126