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(a) Calculate each of the three proposed transfer prices

(b) Discuss how each of the three prices would affect the motivation of each of the divisions to trade on the terms involved

(c) Analyse the range of transfer prices that would be acceptable to both divisions, and also would ensure that their decisions would be in the companys best interests. You should also examine any other transfer price systems that would be appropriate

Light Engineering plc is engaged in a wide range of manufacturing activities, principally in the UK. The company operates on a divisignalised basis, with each division being responsible for its own manufacturing, marketing and working capital management. Divisions are expected to earn at least 20% return on sales A disagreement has arisen between two divisions that operate on adjacent sites. The Office Cleaning Division (OCD) has the opportunity to manufacture a vacuum cleaner using a new linear motor that has recently been developed by the Linear Motor DivisianUMD). At present the only other manufacturer of a comparable motor is a foreign supplier, who can only make one third of OCD's annual requirement of 30,000 motors. They are prepared to sell some or all of these to OCD for 9 per unit. LMD's current selling price is 12. LMD's production line for the motor is currently operating at only 60% capacity, but its budget for next year is based on sales of 100,000 motors, and it expects sales of 120,000 in the following year, when it would be operating at maximum c LMD has offered to supply OCD's requirements for next year at a transfer price equal to its normal selling price less the variable selling and distribution costs that it would not incur on this internal order. OCD have responded with an offer of the standard variable manufacturing cost per unit plus 20%. LMD have rejected this, so the corporate operations director has suggested a third transfer price equal to the standard full manufacturing cost per unit plus 15%. However neither divisional chief executive regards this price as fair. LMDs budget for next year for the production and sale of the motor, based on its standard costs for the forecast 100,000 units, but excluding any sales to OCD is as follows: 000 Sales revenue Direct manufacturing costs Materials 360 230 40 Packaging Indirect manufacturing costs Variable overheads Line production managers Depreciation Capital equipment Capitalised development costs 10 30 150 60 Total manufacturing costs 880 Sales and distribution costs Salaries of sales force Delivery costs 50 20 50 General overheads Total costs 1,000 The costs of the sales force and indirect production staff are not expected to increase up to full capacity Delivery costs are paid to an external contractor Light Engineering plc is engaged in a wide range of manufacturing activities, principally in the UK. The company operates on a divisignalised basis, with each division being responsible for its own manufacturing, marketing and working capital management. Divisions are expected to earn at least 20% return on sales A disagreement has arisen between two divisions that operate on adjacent sites. The Office Cleaning Division (OCD) has the opportunity to manufacture a vacuum cleaner using a new linear motor that has recently been developed by the Linear Motor DivisianUMD). At present the only other manufacturer of a comparable motor is a foreign supplier, who can only make one third of OCD's annual requirement of 30,000 motors. They are prepared to sell some or all of these to OCD for 9 per unit. LMD's current selling price is 12. LMD's production line for the motor is currently operating at only 60% capacity, but its budget for next year is based on sales of 100,000 motors, and it expects sales of 120,000 in the following year, when it would be operating at maximum c LMD has offered to supply OCD's requirements for next year at a transfer price equal to its normal selling price less the variable selling and distribution costs that it would not incur on this internal order. OCD have responded with an offer of the standard variable manufacturing cost per unit plus 20%. LMD have rejected this, so the corporate operations director has suggested a third transfer price equal to the standard full manufacturing cost per unit plus 15%. However neither divisional chief executive regards this price as fair. LMDs budget for next year for the production and sale of the motor, based on its standard costs for the forecast 100,000 units, but excluding any sales to OCD is as follows: 000 Sales revenue Direct manufacturing costs Materials 360 230 40 Packaging Indirect manufacturing costs Variable overheads Line production managers Depreciation Capital equipment Capitalised development costs 10 30 150 60 Total manufacturing costs 880 Sales and distribution costs Salaries of sales force Delivery costs 50 20 50 General overheads Total costs 1,000 The costs of the sales force and indirect production staff are not expected to increase up to full capacity Delivery costs are paid to an external contractor