The Earlswood Company is a multidivisional company which holds divisional managers responsible for their individual profits. The
Question:
The Earlswood Company is a multidivisional company which holds divisional managers responsible for their individual profits.
The Squire Division produces, among other items, an electric motor which the Knight Division uses.
The following information relates to the average unit costs and revenues associated with the electric motor:
Q is the quantity of product which can be transferred.
Required:
(a) Determine the optimal output level to maximize Earlswood's profit and calculate the optimal transfer price consistent with this level. Assume that there is no external market for the intermediate produet.
(b) Show the profits of each division under the optimal solution.
(e) Outline the operational difficulties of applying the optimal solution in practice.
(d) Provide a reasoned argument to identify the circumstances in which the 'true' transfer pricing problem exists and suggest a transfer pricing procedure which may be appropriately used in these circumstances.
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