E7–6 Time allowed: 20 minutes In each of the cases below, assume that Division X has a product that can be sold either to outside customers on an intermediate market or to Division Y of the same company for use in its production process. The managers of the divisions are evaluated based on their divisional profits.

Required 1 Refer to the data in case A above. Assume in this case that £3 per unit in variable costs can be avoided on intra-company sales. If the managers are free to negotiate and make decisions on their own, will a transfer take place? If so, within what range will the transfer price fall? Explain.
2 Refer to the data in case B above. In this case there will be no savings in variable costs on intra-company sales. If the managers are free to negotiate and make decisions on their own, will a transfer take place? If so, within what range will the transfer price fall? Explain.

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Division X: Capacity in units Number of units being sold on the intermediate market Selling price per unit on the intermediate market Variable costs per unit Fixed costs per unit (based on capacity) Division Y: Number of units needed for production Purchase price per unit now being paid to an outside supplier Case A B 200,000 200,000 200,000 160,000 90 75 70 60 13 8 40,000 40,000 86 74