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.

Required:

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

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

(1 mark)

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

                                                                                                      

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

Answer 1

1. Range of Transfer price that promotes goal congruence

(i) Minimum Transfer price (by supplying division) = Additional outlay cost + Opportunity cost (if any)

Additional outlay cost = Marginal cost + Any additional incidental costs incurred by supplying division

Therefore,

Minimum transfer price = (40*15500+78*3000)/18500 = $46.16

Available capacity 55000

Outside demand = 39500

Idle Capacity = 55000-39500 = 15500 - So there is no opportunity cost for these units and these can

be supplied at Marginal costs

Units required by Purchasing division = 18500

Shortfall = 18500-15500 = 3000 units (these units are to be supplied to the purchasing division, so the supplying division has to loose outside sales, in this case, there is opportunity loss here, hence we have considered this opportunity loss while calculating Minimum Transfer price)

(ii) Maximum Transfer price (by purchasing division)

= Lower of Net Marginal Revenue and external buy-in price

Information relating to Net marginal revenue is not available,

Then Maximum TP = External Buy-in price

= $75

Range 4.16 75

2) Yes, it is beneficial to both the divisions and whole company, and the price $50 is with in the above range

3) Minimum transfer price = (40*7500+78*11000)/18500 $62.59

Available capacity 55000

Outside demand = 47500

Idle Capacity = 55000-47500 = 7500- So there is no opportunity cost for these units and these can be supplied at Marginal cost

Units required by Purchasing division = 18500

Shortfall = 18500-7500 = 11000 units

(these units are to be supplied to the purchasing division, so the supplying division has to loose outside sales, in this case, there is opportunity loss here, hence we have considered this opportunity loss while calculating Minimum Transfer price)

(ii) Maximum TP External Buy-in price = $75

Range 62.15 75

Supplying division may not accept to supply at $50