HKI plc has an Engineering Division and a Motorcycle Division. The Engineering Division produces engines which it sells to 'outside' customers and transfers to the Motorcycle Division. The Motorcycle Division produces a powerful motorbike called the 'Beast' which incorporates an HKI engine in its design.
The Divisional Managers have full control over the commercial policy of their respective Divisions and are each paid 1 per cent of the profit that is earned by their Divisions as an incentive bonus. Details of the Engineering Division's production operation for the next year are expected to be as follows:
Annual fixed costs £3 000 000
Variable cost per engine £350
Details of the Motorcycle Division's production operation for the next year are expected to be as follows:
Annual fixed costs £50 000
Variable cost per Beast £700*
*This figure excludes transfer costs
Both Divisions have significant surplus capacity. Market research has indicated that demand from 'outside' customers for HKI plcs products is as follows:
•9000 engines are sold at a unit selling price of £700; sales change by an average of 10 engines for each £1 change in the selling price per engine;
•1000 Beasts are sold at a unit selling price of £2200; sales change by an average of 125 Beasts for each £100 change in the selling price per Beast.
It is established practice for the Engineering Division to transfer engines to the Motorcycle Division at 'market selling price'.
(a) to calculate the unit selling price of the Beast (accurate to the nearest penny) that should be set in order to maximize HKI plc's profit;
(b) to calculate the selling price of the Beast (accurate to the nearest penny) that is likely to emerge if the Engineering Division Manager sets a market selling price for the engine which is calculated to maximize profit from engine sales to outside customers. You may assume that both Divisional Managers are aware of the information given above Explain your reasoning and show your workings;
(c) to explain why you agree or disagree with the following statement made by the Financial Director of HKI plc: 'Pricing policy is a difficult area which offers considerable scope for dysfunctional behavior. Decisions about selling prices should be removed from the control of Divisional Managers and made the responsibility of a Head Office department.'