EXERCISE 2

A company has 2 divisions: division A (DA) in Spain and division B (DB) in Ireland. DA produces a component sold to DB that DB sells to end-users. DA can produce 1,000 units of the component per year. Actually, it produces 700 units that are incorporated in the same number of final products that DB sells to end-users for 905 .

Data of DA:

• Variable cost/unit 435
• Fixed cost/unit 75

FULL COST/UNIT 510

Data of DB:

• Variable cost/unit 125
• Fixed cost/unit 55

FULL COST/UNIT 180

An external supplier offers DB 300 units of the same product provided by DA at 450 . DB has the capacity to process those extra 300 units.

1. Calculate the cost of a) buying those 300 units from the external supplier and b) buying those 300 extra units internally? Assume the total fixed cost of DA is the same regardless of the alternative chosen.
2. Suppose corporate managers decide to fix a transfer price of 102% of the full cost. What will be more profitable for the company, to a) buy externally or b) internally?
3. What would be the minimum and maximum prices that would lead to goal congruence for those 300 units.
4. What would be the net income for each division and for the corporation if the transfer price is fixed at a) the market price and b) at 102% of full cost? Suppose 700 units are produced and sold internally. Corporate taxes are 30% in Spain and 12.5% in Ireland. Assume no interest revenues nor expenses.