KNM Company is specialty manufacturer of a wide variety of industrial chemicals and adhesives. Much of the raw material is purchased in bulk from other chemical companies. One of the chemicals, X2, is prepared in one of KNM’s own plants, the X2 unit. X2 is shipped to other KNM plants at a given internal price.
The KNM plant in KSA requires 20,000 barrels of X2 per month and can purchase from outside the firm for $300 per barrel. KNM’s X2 unit has a capacity of 40,000 barrels per month and is presently selling that quantity to outside buyers at $330 per barrel. The difference between the X2 unit’s price of $330 and the competitors’ price of $300 is due to short-term pricing strategy only; the materials are equivalent in quality and functionality. The X2 unit’s selling cost is $10 per barrel, and the X2 unit’s variable cost of manufacturing is $180 per barrel.

Required:
1. Should the KSA plant purchase X2 from inside or outside the firm?
2. Based on your answer in requirement a, recommend the proper transfer price for X2.
3. How would your answer to requirement a and b change if the X2 unit had a capacity of 60,000 barrels per month?
4. Explain why setting transfer prices by KNM can be controversial when a product is being transferred between two profit centers.