Question

Bobby & Brown (BB) Plc is a multinational corporation. The company has a business division, BB Tyres, that manufactures tyres for motorcycles and cars. There is an automobile division of the company, BB Automobile, that manufactures cars.

BB Automobile purchase tyres for its automobiles from an outside vendor. However, at the end of the current month, the contract with the vendor for the tyres of vans will expire. The senior management of BB Plc feels that the automobile division of the company should purchase tyres for vans from its own tyre division rather than renewing the contract with the outside vendor. The managers of both the divisions are also interested in having intra-company transactions as it will be in the best interests of both the divisions as well as the company as a whole.

The tyres manufactured by BB Tyres are of standard size. BB Automobile needs 18,500 tyres per month to manufacture vans. The quality of the tyres supplied by the outside vendor and the ones manufactured by BB Tyres are similar. BB Automobile currently pays $75.00 to the outside vendor for a tyre of van. The Tyres division of BB Plc currently sells the tyres to its existing customers at $78.00 each. The production capacity of the division is 55,000 van tyres per month. The variable cost to produce one van tyre is $40.00. The fixed cost incurred in the manufacture of van tyres is $105,000 per month.

3. If BB Tyres’ monthly sales is 55,000 van tyres, would transfer take place?

Why or why not?                                                                                         

          (1.5 marks)

      4. How does the presence or absence of idle capacity affect the optimal transfer-pricing

           policy?                        

Answer 1