Problem 5 Transfer Pricing (20 marks)

Problem 5 - Transfer Pricing (20 marks) BP Corporation has two divisions, Extraction and Refining. The Extraction Division extracts barrels of crude oil and sell them either to the Refining Division or the third parties. The Refining Division processes each barrel of oil to make the company's primary product Luboil Oil. Each division's costs are provided below: The Refining Division has been operating at a capacity of 40,200 barrels a day and usually purchases 25,200 barrels of crude oil from the Extraction Division and 15,000 barrels from other suppliers in the market at $58 per barrel. a. What's the market-based transfer price for each barrel of crude oil from the Extraction Division to the Refining Division? (2 marks) b. What is the transfer price per barrel from the Extraction Division to the Refining Division, assuming the transfer price is 180% of variable costs? (3 marks) c. What is the transfer price per barrel from the Extraction Division to the Refining Division, assuming the transfer price is 120% of full costs? (3 marks) d. Assume the Extraction Division processes 260 barrels in one batch. Each batch (i.e., 260 barrels) is then transferred from the Extraction Division to the Refining Division for a transfer price of $26 per barrel. The Refining Division sells the 260 barrels at a price of $220 each to customers. What is the operating income of both divisions together for each batch? ( 3 marks) Refer to the general guideline for transfer pricing, please answer part e and below: e. Suppose the Extraction Division has sufficient capacity, what's the minimum transfer price that it will accept to sell additional barrels of crude oil? ( 3 marks) f. Suppose the Extraction Division is currently operating at its full capacity, what's the minimum transfer price that it will accept to sell add additional barrels of oil? (3 marks) g. "Under the general guideline for transfer pricing, the minimum transfer price will vary depending on whether the supplying division has unused capacity or not." Do you agree? Explain