Eutronics has two divisions – Division A manufactures compressors and Division B uses compressors to make air conditioners. Each division operates as a profit centre and is free to buy and sell products internally and externally. The revenue and cost of a compressor is shown below:

Capacity...................................................................15,000

Selling price to external customers.............................$180

Direct Materials...............................................................20

Direct Labours................................................................60

Variable Manufacturing Costs........................................10

Fixed Manufacturing Costs (based on capacity)............45

Division B currently purchases 6,000 compressors from Division A at full cost. A salesperson approached Division B and offered to sell the compressors at $120. The manager of Division B is negotiating the price with the manager of Division A.

Required:

A. If Division A operates at 50% of its capacity and can produce 6,000 compressors for Division B, what is the range of the transfer price, if any? If you were the manager of Division A, what transfer price would you offer the manager of Division B?

B. If Division A operates at 90% of its capacity and needs to give up 4,500 units of its existing sales to transfer 6,000 compressors to Division B, what is the range of the transfer price, if any? If you were the manager of Division A, what transfer price would you offer the manager of Division B?

C. If Division A’s tax rate is 30% and Division B’s tax rate is 45%, and Division A operates at 50% of its capacity, what should the transfer price be to maximize Eutronics’ profit and minimize its taxes? Will each manager prefer to use cost or market price as the transfer price? Explain.