XYZ a diversified group of the company allows its divisional management some degree of freedom in managing their own business units. 

Division H manufactures only one type of product, a chip, which it sells to external customers and also to division   L,   another member of the   Group.  Division   L processes the chip further and sells it to external customers as a finished product. Due to the high quality of Division H’s chip, the current policy of the group is for H to transfer to Division L at the marginal cost of £7.5 per chip all the chips L needs and that L buys all the chips it requires from H. Budgeted data taken from the group internal information system, for the divisions for the next year is as follows.

 transferred components.  Regarding Division H, of the budgeted production and sales, 12,000 units are transferred to Division L and as a result of the current capacity within Division H, only 8,000 units of the external demand can be satisfied. Three measures are currently used to evaluate the performance of the divisional managers: Return on Investment (ROI), Residual Income (RI) and net profit margin in relation to sales.  The company uses a target Return on Capital of 12% pa.  

Required:

a) Based on the current practice, of pricing transfers at variable cost, calculate the budget profit and budgeted performance measures for H and L.

b) If the transfer price of the component is set by the manager of Division H at the current market price (£12.5) recalculate the budgeted performance measures for each division

c) Analyze the changes to the performance measures of the divisions as a result of altering the transfer price. 

d) Discuss the advantages and disadvantages of decentralization in organizations.

e) Discuss the implication of full autonomy with regard to the above calculations.

f) Indicate the principal methods of determining transfer prices in multinational corporations and indicate what effects these can have on sister-companies trading with each other when performance measurement is based on a profit center or investment center basis

Income Statement Total Sales Value Variable costs (per unit) Fixed costs (controllable) Capacity (units) Budget Production / Sales (units) Production transferred (units) External market demand (units) External market supplied (units) Market Price Capital Employed Division H 190,000 7.50 30,000 20,000 20,000 12,000 14,000 8,000 12.50 100,000 Division L 570,000 14 200,000 20,000 12,000 47.50 200,000 The variable cost per unit of Division L shown above does not include the cost of the