Question

Matuku's Fishing Supplies has two divisions, Basic and Deep Sea. Each division manager is evaluated based on profit produced by each division. The Basic division often sells a certain graphite fishing rod internally to the Deep Sea division for $40 per rod to cover variable costs. The Basic division also sells the same graphite rod to outside customers for $50 per rod. The Deep Sea division manager has the option of purchasing a similar rod from an outside supplier for $45.

Required (show your workings for each question):

I) Using the general transfer pricing rule, calculate the optimal transfer price assuming the Basic division is operating below capacity. (1 mark)

II) Calculate the optimal transfer price assuming the Basic division is operating at full capacity. (1 mark)

III) The company's CEO recently established the following policy: all internal transfers will be made at variable cost plus 10 percent. Assume the Basic division is operating below capacity. As the Deep Sea division manager, what would you do: purchase internally or purchase from an outside supplier? Why? (2 marks)