3 (25 marks) Super Appliance Manufacturers Ltd has a wide range of manufacturing activities. The company operates on a divisionalised basis with each division being responsible for its own manufacturing, sales and marketing, and working capital management. Divisional chief executives are expected to achieve a target of 20% return on sales. A disagreement has arisen between two divisions which operate on adjacent sites. The Boiler division has the opportunity to manufacture a geyser using a new heater element developed by the Electric division. Currently there is no other source of supply for an equivalent heater. in the required quantity of 45 000 units a year, although a foreign manufacturer has offered to supply up to 15 000 units in the coming year at a price of N$13.50 each. Electric's current Page 11 of 16 FACULTY OF COMMERCE, MANAGEMENT AND LAW selling price for the heater is N$18. Although Electric's production line is currently operating at only 50% of capacity, sales are encouraging and Electric confidently expects to sell 150 000 units in 2022, and its maximum output of 180 000 units in 2023. Electric has offered Boiler's requirements for 2022 at a transfer price equal to the normal selling price, less the variable selling and distribution costs that it would not incur on this internal order. Boiler responded by offering an alternative transfer price of the standard variable manufacturing cost plus a 20% margin on selling price. The two divisions have been unable to agree, so the corporate operations director has suggested a third transfer price equal to the standard full manufacturing cost plus 15%. However, neither divisional chief executive regards such a price as fair.. Electric's 2022 budget for the production and sale of heaters, based on its standard costs for the forecast 150 000 units sales, but excluding the possible sales to Boiler, is as follows: Sales revenue (150 000 units @ N$18 each) Direct Manufacturing costs Bought in materials Labour Packaging Indirect manufacturing costs Variable overheads Line production salaries Depreciation Capital equipment Capitalised development costs Total manufacturing costs Sales and distribution costs Salaries of sales force Carriage General overhead Total costs Profit Additional information N$000 2 700 540 635 60 15 45 225 90 1 610 75 30 75 1 790 910 1. The costs of the sales force and indirect production staff are not expected to increase up to the current production capacity. 2. General overhead includes allocation of divisional administrative expenses and corporate charges of N$20 000 specifically related to this product. 3. Depreciation for all assets is charged on a straight-line basis using a five-year life span and no residual value. 4. Carriage is provided by an outside contractor. Page 12 of 16 FACULTY OF COMMERCE, MANAGEMENT AND LAW Required Calculate each of the three proposed transfer prices and comment on 3.1 how each might affect the willingness of Electric's chief executive to engage in inter-divisional trade. Outline an alternative method of setting transfer prices which you 3.2 consider to be appropriate for this situation, and explain why it is an improvement on the other proposals. Total marks Marks Sub- Total total 20 20 20 5 25 25