Division A, which is a part of the ACF Group, manufactures only one type of product, a Bit,

which it sells to external customers and to division C, another member of the group.

ACF Group's policy is that divisions have the freedom to set transfer prices and choose their

suppliers.

The ACF Group uses residual income (RI) to assess divisional performance and each year it

sets each division a target RI. The group's cost of capital is 12% a year.

Division A

Budgeted information for the coming year is:

Maximum capacity 150,000 Bits

External sales 110,000 Bits

External selling price $35 per Bit

Variable cost $22 per Bit

Fixed costs $1,080,000

Capital employed $3,200,000

Target residual income $180,000

Division C

Division C has found two other companies willing to supply Bits:

X could supply at $28 per Bit, but only for annual orders more than 50,000 Bits.

Z could supply at $33 per Bit for any quantity ordered.

Division C provisionally requests a quotation for 60,000 Bits from division A for the coming

year.

Required:

(a) Calculate the transfer price per Bit that division A should quote to meet its

residual income target. (6 marks)

(b) Calculate the two prices division A would have to quote to division C, if it became

group policy to quote transfer prices based on opportunity costs.

(4 marks)

(Total: 10 marks