1. Garden Company is an integrated multidivisional manufacturing firm. Two of its divisions, Motor and Assembly, are profit centres and their division managers have full responsibility for production and sales (both internal and external). Both the Motor and Assembly manager are evaluated by top management based on total profit.

Motor is the exclusive producer of a special component called QS 40. Since there is no outside competition for QS-40, the Motor division manager used the results of a market study to set the price of $550 for each unit. Normal sales are 21,000 per year. Production capacity is 26,000 per year. Standard production costs for one unit of QS-40 based on normal production volume are as follows:

Direct materials $175

Direct labour 75

Variable overhead 60

Fixed overhead 100

Total unit production costs $410.00

Assembly Division produces machinery for several large customers on a contractual basis. Management have been approached by a manufacturer of industrial greenhouses to produce a sprinkler system for greenhouses. QS-40 is a component of the sprinkler system. Potentially each greenhouse may need several sprinkler systems. The new customer order size is 15,000 units per year at a price of $ 750 per unit.

The manager of the Assembly Division calculated the unit costs to produce the special machine as follows (direct materials does not include QS-40):

Direct materials $100

Direct labour 50

Variable overhead 35

Fixed overhead 45

Total unit production costs $230

Required:

1. What is the maximum unit transfer price that Assembly would be willing to pay for QS-40 if the division wishes to accept the contract for the sprinkler system?
2. What is the minimum unit transfer price that Motor division should be willing to accept for QS-40? Based on a and b will a transfer occur?
3. Assume that Motor Divisions would be able to sell its capacity of 26,000 units of QS -40 per year if the selling price is reduced by 10%. Evaluate from the view of top management the quantitative and qualitative factors of selling internally or reducing price and selling externally. If none are sold internally then Assembly division will not be able to make Sprinkler system.

4. Assume top management decide to impose a dual transfer pricing system for QS-40 which would satisfy the Motor and Assembly managers. Discuss the implications of this decision.

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