Division X: Division X produces ingredient A, which it sells to both external customers and to Division Y at 40 per kg. Maximum operating capacity of Division X is 600,000 kg of ingredient A and all units produced are sold. Forty percent (40%) of its annual sales are to Division Y and the remainder are sold to meet the full demand of its external customers. Division X bases its market and transfer price of ingredient A on total cost plus 25% profit mark-up. Its total costs are 80% variable and 20% fixed. The variable cost of ingredient A however includes a selling cost of 3.60 per kg not incurred on sales made to Division Y. The manager of Division X expects external demand, costs and selling price of ingredient A to remain stable for the foreseeable future.

Division Y: Division Y currently purchases all of its ingredient A requirement from Division X only. It uses 4 kg of the ingredient A to make product B, which is sold to external customers only at 500 per unit. At that price, all units produced are sold to meet its full maximum demand. The variable cost of product B, including the cost of purchasing ingredient A from Division X is 360 per unit. Annual fixed costs are 4 million.

(a) Calculate the current annual profits earned by Division X and Division Y.

(b) Recently an external supplier has approached Division Y and has offered to supply it with an unlimited supply of ingredient A for 28 per kg, with the possibility of an additional 10% discount in the future for bulk purchases. Prior to this offer, the cheapest price that ingredient A could have been purchased from outside was 42 per kg. Discuss and advise on the minimum and maximum suitable transfer prices that will be acceptable to both divisions. You should use supporting calculations to illustrate your answer.