Advanced: Calculating optimum transfer prices and profits using differential calculus Megacorp pic is a divisionalized enterprise. Among
Question:
Advanced: Calculating optimum transfer prices and profits using differential calculus Megacorp pic is a divisionalized enterprise. Among its divisions are Chem and Drink. Both of these divisions have a wide range of independent activities. One product, Fizz, is made by Chem for Drink. Chem does not have any external customers for the product.
The central management of Megacorp pic del¬ egates all pricing decisions to divisional manage¬ ment, and the pricing of Fizz has been a conten¬ tious issue. It has been suggested that Chem should give a transfer price schedule for the supply of Fizz, based on Chem’s own production costs, and that all transfers would be made at Chem’s marginal cost. Drink would then order the quantity it requires each month.
Chem estimates its monthly total costs, TCc, for producing Fizz are as follows:
where Qn is the quantity of product, each unit of which incorporates one unit of Fizz.
Drink estimates that the demand function for its product incorporating Fizz is:
Requirements
(a) (i) Calculate the quantity of Fizz production which would maximize profits for Mega- corp pic;
(ii) calculate the transfer price correspond¬ ing to that production if Chem’s marginal cost is adopted for transfer pricing, and show the resulting profits for each divi¬ sion. (6 marks)
(b) (i) Calculate the quantity of Fizz which Drink would take (at Chem’s marginal cost) if it wanted to maximize its own profits-, (ii) calculate the transfer price correspond¬ ing to that quantity, and show the result¬ ing profits for each division. (5 marks)
(c) Examine the implications for Megacorp pic of the transfer pricing issues involved in require¬ ments
(a) and (b). (6 marks)
(d) Briefly describe the other main methods of transfer pricing and discuss their limitations.
(8 marks) (Total 25 marks) ICAEW Management Accounting
Step by Step Answer:
