Discussion of transfer price where there is an external market for the intermediate product Fabri Division is part of the Multo Group. Fabri Division produces a single product for which it has an external market which utilizes 70% of its production capacity. Gini Division, which is also part of the Multo Group requires units of the product available from Fabri Division which it will then convert and sell to an external customer. Gini Division's requirements are equal to 50% of Fabri Division's production capacity. Gini Division has a potential source of supply from outside the Multo Group. It is not yet known if this source is willing to supply on the basis of (i) only supplying all of Gini Division's requirements or (ii) supplying any part of Gini Division's requirements as requested.

(a) Discuss the transfer pricing method by which Fabri Division should offer to transfer its product to Gini Division in order that group profit maximization is likely to follow. You may illustrate your answer with figures of your choice. (14 marks)

(b) Explain ways in which (i) the degree of divisional autonomy allowed and (ii) the divi- sional performance measure in use by Multo Group may affect the transfer pricing policy of Fabri Division. (6 marks)