CLUK is a producer of sports nutrition drinks and has two divisions, D1 and D2. Division D1 manufactures recyclable plastic containers which it sells to both Division D2 and also external customers.Division D2 makes high protein drinks which it sells to the retail trade in the containers that it purchases from Division D1.

You have been provided with the following budget information for Division D1:

Selling price to retail customers per 1,000 containers 130

Variable costs per container 0.04

Fixed Costs per annum 2.4 million

Net Assets 4.0 million

Production capacity 40,000,000 containers

Retail demand for containers 38,000,000 containers

Demand for containers from Division D2 20,000,000 containers

You have been provided with the following budget information for Division D2:

Selling per container of protein drink 0.50

Variable costs per drink (excluding container) 0.15

Cost per container (from Division D1) At transfer price

Fixed Costs 1,750,000

Net assets 12,650.000

Sales volume of protein drinks in containers 20,000,000

Transfer Pricing Policy

Division D1 is required to satisfy the demand of Division D2 before selling containers externally. The transfer price for a container is full cost plus 20%.

Performance Management Targets

Divisional performance is assessed on Return on Investment (ROI) and Residual Income (RI).Divisional managers are awarded a bonus if they achieve the annual ROI target of 25%. CLUK has a cost of capital of 7%.

(i) Produce a profit statement for each division detailing sales and costs, separating external sales and inter-divisional transfers.

(ii)Calculate the ROI for division D1 and division D2.

(iii)Provide a brief commentary on the divisionalised profit statements and ROI results shown in (i) and (ii)

(b)The directors of CLUK are planning to expand the operations of the company and together with the divisional managers, have agreed to purchase a new machine that would increase annual production capacity to 50,000,000 cans at Division D1.

The purchase of this machine will increase the net assets of Division D1 by $500,000. Assume that there is no impact on unit variable costs or fixed costs resulting from this purchase.Inter-divisional transfers will be priced at opportunity cost.

Produce a report to the directors critically discussing the issues and implications of the Transfer Pricing Policy on this investment and divisional profits.Support your answer with suitable analysis and revised profit statements.