Question

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

HL 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 HL 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 HL Tyres are of standard size. HL 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 HL Tyres are similar. HL Automobile currently pays $75.00 to the outside vendor for a tyre of van. The Tyres division of HL 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.

Required:

1. a. Determine the acceptable range of transfer price if HL Tyres sells 39,500 van tyres to its external customers per month. (Round your answer to 2 decimal places.)                                                                                                                            

b. If HL Automobile proposes to buy van tyres at $50.00 each from HL Tyres, would   the management of HL Tyres be interested in the proposal?                               

(1 mark)

2. a. HL Automobile proposes to buy van tyres at $50.00 each from BB Tyres. Determine the acceptable range of transfer price if HL Tyres sells 47,500 van tyres to its external customers per month. (Round your answer to 2 decimal places.)

                                                                                                      

2. Will the management of HL Tyres accept the proposal?                      

(1 mark)

3. If HL 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

Fixed Cost per unit		is 105000/55000
		1.91
Varible cost per unit		40.00
Total Cost		41.91
1a)Determine the acceptable range of transfer price if HL Tyres sells 39,500 van tyres to its external customers per month.
Production capacity	a	55000.00
Outside sales	b	39500.00
Idle capacity	c=a-b	15500.00
Inhouse Tyre required	d	18500.00
Sales to be forgone if supplied in house	d-c	3000.00
		Considering varible cost only	Considering total cost
Price to be charged for 3000 units		234000.00	234000.00
		(3000*78)	(3000*78)
Price to be charged for 15500 units		620000.00	649605.00
		(15500*40)	(15500*41.91)
Total Cost		854000.00	883605.00
Per unit Price Range		46.16	47.76
		(854000/18500)	(883605/18500)
1.b. If HL Automobile proposes to buy van tyres at $50.00 each from HL Tyres, would   the management of HL Tyres be interested in the proposal?
>>Yes
2.HL Automobile proposes to buy van tyres at $50.00 each from BB Tyres.
Determine the acceptable range of transfer price if HL Tyres sells 47,500 van tyres to its external customers per month.
Production capacity	a	55000.00
Outside sales	b	47500.00
Idle capacity	c=a-b	7500.00
Inhouse Tyre required	d	18500.00
Sales to be forgone if supplied in house	d-c	11000.00
		Considering varible cost only	Considering total cost
Price to be charged for 7500 units		585000.00	585000.00
		(7500*78)	(7500*78)
Price to be charged for 11000 units		440000.00	461010.00
		(11000*40)	(11000*41.91)
Total Cost		1025000.00	1046010.00
Per unit Price Range		55.41	56.54
		(1025000/18500)	(1046010/18500)
It would be better to buy from outside at $ 50.
3a. Will the management of HL Tyres accept the proposal?
If HL Tyres’ monthly sales is 55,000 van tyres, would transfer take place?Why or why not?
>> No because of opportunity cost as the Management can sell the Tyres outside at $ 78 while the buying from outside costs $ 75.
4.How does the presence or absence of idle capacity affect the optimal transfer-pricing policy?
>> For idle capicity, there is no opportunity cost attached, so only variable cost is the expenditure of production
if there is no idle capicity , we have to forgo outside sales and therby profit to fullfill that inhouse requirement
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