Comfy Chairs Co manufactures a standard office chair in Division A. The standard chair is improved in Division B with extra cushioning and easy-run castors. The manager of Division A has offered Division B a transfer price of £10 per chair to cover variable cost of £8 plus £2 for profit.

The estimated selling prices for a range of weekly output from Division B are as follows:

The variable costs and fixed costs of each division are as follows:
Variable cost Division A: £8 per chair Division B: £7 per chair for additional upholstery and castors Fixed cost Division A: £200 per month Division B: £60 per month Required

(a) Show that on the basis of a transfer price of £10 per chair the manager of Division B will prefer a level of activity that is not the best solution for the company as a whole.

(b) Show that if the transfer price is equal to the marginal cost (variable cost) of Division A then the manager of Division B will make a choice that is the best solution for the company as a whole.

(c) Discuss the view of the manager of Division A regarding a marginal cost transfer price.

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Estimates of selling prices for different levels of demand Weekly output of chairs Selling price per chair 24 23 22 21 20 19 30 40 50 60 70 80