Hiddleston plc is a well-known company that manufactures apparel and watches for both men and women. It has huge retail stores in many major cities across the country. It has separate divisions for men’s clothing, women’s clothing, men’s wristwatches and women’s wristwatches. Recently, Hiddleston has started manufacturing and selling children’s clothes. Division MW of Hiddleston plc manufactures and sells analogue wristwatches for men. It manufactures and sells two types of wristwatch: watches with straps made of stainless steel and watches with straps made of leather. It purchases the straps required for the watches from two external vendors. It pays £10.50 per leather strap and £9.50 per stainless steel strap. It manufactures and sells 20,000 men’s watches with leather straps and 18,000 men’s watches with stainless steel straps in a month. It manufactures and sells 15,000 women’s watches with leather straps and 10,000 women’s watches with stainless steel straps in a month. Hiddleston plc recently purchased a new division – Division B. Division B manufactures and sells different types of strap for wristwatches. It manufactures leather straps for wristwatches for both men and women. It has a capacity to manufacture 50,000 leather straps in a month only for men’s wristwatches. It currently sells these leather straps to its external customers at £12.50 per strap. It sells stainless steel straps at £11.50 per strap. The variable cost incurred only for leather straps for men’s wristwatches is £5 per unit. The variable
cost incurred only for stainless steel straps for men’s wristwatches is £4 per unit. Hiddleston plc has suggested that Division MW should purchase the straps for its watches from Division B. To start with, Division MW has proposed to buy 20,000 leather straps for men’s wristwatches every month from Division B.

Required
1. Division MW has proposed purchasing leather straps at £7.50 each from Division B. Division B has an unused capacity to manufacture 10,000 leather straps. Should the manager of Division B accept the proposal?
2. The external vendor who supplies leather straps for men’s wristwatches has increased the selling price from £10.50 to £13.00. Hence, Division MW agreed to buy leather straps for men’s wristwatches from Division B at a market price of £12.50 per leather strap. Briefly explain how the transfer price affects Hiddleston plc when:
(a) Division B has no idle capacity.
(b) Division B has sufficient idle capacity.
3. Division MW and Division B agree to set the transfer price equivalent to the absorption cost. Describe the advantages and disadvantages of setting the transfer price at the cost of the selling division.