Bubbling Springs, Inc., produces bottled drinks. Division #1 acquires the water, adds carbonation, and sells it in bulk quantities to Division # 2 of Spring Waters and to outside buyers. Division # 2 buys carbonated water in bulk, adds flavoring, bottles it, and sells it. Last year, Division #1 produced 1,500,000 gallons, of which it sold 1,300,000 gallons to the Division # 2 and the remaining 200,000 gallons to outsiders for $0.40 per gallon. Division #2 processed the 1,300,000 gallons, which it sold for $1,500,000. Division #1s variable costs were $440,000 and its fixed costs were $120,000. The Division # 2 incurred an additional variable cost of $320,000 and $200,000 of fixed costs. Both divisions operated below capacity.

Required:

a. Prepare division income statements assuming the transfer price is at the external market price of $0.40 per gallon.

b. Repeat part a. assuming a negotiated transfer price of $0.30 per gallon is used.

c. Respond to the statement: The choice of a particular transfer price is immaterial to the company as a whole.