Company C is engaged in synthetic fibre production. It is situated in Country A where it operates two production plants.

Plant 1 manufactures a single product, which is a special grade of polymer.

The polymer is then transferred to Plant 2 which produces a synthetic fibre, ‘Synfib’. The polymer produced by plant 1 is of a special grade and manufactured specifically for the production of Synfib, so there is no intermediate local market for it except that a foreign customer find the use for this special grade polymer.

There is strong worldwide demand for Synfib and Company C is the only producer, although substitute products are available. The following schedule shows the monthly demand for Synfib.

Litres (million)	$ per litre
75	205
100	195
125	143

The manager of Plant 2 has autonomy to choose the level of output of Synfib, and always selects the level of output which maximises Plant 2’s contribution. Output of Synfib is produced in batches of 25 million litres. The minimum monthly quantity produced is 75 million litres, and the maximum monthly demand is 125 million litres (which is the maximum quantity that can be produced each month).

The marginal costs incurred in the production of Synfib are as follows:

	$ per litre
Costs incurred within Plant 1	12
Costs incurred within Plant 2	24

The transfer price for the polymer has been set at $42 per litre. Plant 1 can normally sell its polymer to a foreign customer for 100 million litres. Recently, the divisional manager of Plant 2 has argued that the transfer price of $42 per litre is too high. She believes that a transfer price set at Plant 1’s marginal cost of $12 per litre would result in increased contribution for C as a whole.

Compute the net impact on Company C’s profit if the transfer price is set at the rate by plant 1.

Answer rating: 100% (QA)

When the marginal cost of Plant 1 is 12 and Plant 2 is ... View the full answer