From: Anthony, R. N., and Govindarajan, V. 2007. Management Control Systems, 12th Edition, McGraw-Hill.

It is the question in the book of Chapter 6C.1, Problem 5P ( transfer pricing)

5. Two of the divisions of the Chambers Corporation are the Intermediate Division and the Final Division. The Intermediate Division produces three products: A, B, and C. Normally these products are sold both to outside cus- tomers and to the Final Division. The Final Division uses Products A, B, and C in manufacturing Products X, Y, and Z, respectively. In recent weeks, the supply of Products A, B, and C has tightened to such an extent that the Final Division has been operating considerably below capacity because of the lack of these products. Consequently, the Intermediate Division has been told to sell all its products to the Final Division. The financial facts about these products are as follows: Intermediate Division Product A Product C Product B $ 10.00 6.00 Transfer price Variable manufacturing cost Contribution per unit Fixed costs (total) $ 10.00 3.00 $ 7.00 $50,000 $ 15.00 5.00 $ 10.00 $75,000 $ 4.00 $100,000 Part One The Management Control Environment The Intermediate Division has a monthly capacity of 50,000 units. The processing constraints are such that capacity production can be obtained only by producing at least 10,000 units of each product. The remaining capacity can be used to produce 20,000 units of any combination of the three products. The Intermediate Division cannot exceed the capacity of 50,000 units. The Final Division has sufficient capacity to produce about 40 percent more than it is now producing because the availability of Products A, B, and C is limiting production. Also, the Final Division can sell all the products that it can produce at the prices indicated above. Final Division Product X Product Z Product Y $ 30.00 $ 28.00 $ 30.00 15.00 8.00 Selling price Variable cost: Inside purchases Other variable costs Total variable cost Contribution per unit. Fixed costs (total).. 10.00 5.00 $ 15.00 $ 13.00 $100,000 10.00 5.00 $ 15.00 $ 15.00 $100,000 $ 23.00 $ 7.00 $200,000 Questions a. If you were the manager of the Intermediate Division, what products would you sell to the Final Division? What is the amount of profit that you would earn on these sales? b. If you were the manager of the Final Division, what products would you order from the Intermediate Division, assuming that the Intermediate Division must sell all its production to you? What profits would you earn? c. What production pattern optimizes total company profit? How does this affect the profits of the Intermediate Division? If you were the executive vice president of Chambers and prescribed this optimum pattern, what, if anything, would you do about the distribution of profits between the two divisions? 6. How, if at all, would your answers to Problem 5 change if there were no out- side markets for Products A, B, or C