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

Fixed cost should not be considered as FC should remain same irrespective of no of unit of production thus irrelevant cost

In order to provide 18500 tires to Automibile department we have to add up cost of opportunity lost of selling (55000-18500=36500, 39500-36500=3000) 3000 units to external customer. Thus the resulting transfer price shall be 52.65

b) In case Autombile segment offer to purchase tires at 50 per tire in that scenario Tire segment should let down the proposal. As transfer price to produce a tire is coming up to 52.65 per tire which is 2.65 more then what automobile segment is offering.

2 a)

In case we are having external customers for selling 47500 units then we have to bear the opportunity lost of selling 11000 units (55000-18500-47500) to external customer. Due to which the transfer price shall rise. Thus In here the transfer price of transfering tires to Automobile dept shall be 86.38

b) Management of BB tires should not accept the offer if the Automobile segment ask them to supply tires. As the costing of a sigle tire to them is 86.38 however the Automibile sector can easily purchase the same from the market at 72 per tire. Purchasing from Tire segment is inappropriate as per pricing comparison.