AB Ltd has two Divisions A and B. Division A manufactures a product called the aye
Question:
AB Ltd has two Divisions – A and B. Division A manufactures a product called the aye and Division B manufactures a product called the bee. Each bee uses a single aye as a component. A is the only manufacturer of the aye and supplies both B and outside customers.
Details of A’s and B’s operations for the coming period are as follows:
Market research has indicated that demand for AB Ltd’s products from outside customers will be as follows in the coming period:
•the aye: at unit price £1000 no ayes will be demanded but demand will increase by 25 ayes with every £1 that the unit price is reduced below £1000;
•the bee: at unit price £4000 no bees will be demanded, but demand will increase by 10 bees with every £1 that the unit price is reduced below £4000.
Requirements:
(a) Calculate the unit selling price of the bee (accurate to the nearest £) that will maximize AB Ltd’s profit in the coming period.
(b) Calculate the unit selling price of the bee (accurate to the nearest £) that is likely to emerge if the Divisional Managers of A and B both set selling prices calculated to maximize Divisional profit from sales to outside customers and the transfer price of ayes going from A to B is set at ‘market selling price’.
(c) Explain why your answers to parts (a) and (b) are different, and propose changes to the system of transfer pricing in order to ensure that AB Ltd is charging its customers at optimum prices.
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