Question $1$

$(20$ marks$)$

Division A$,$ manufactures a component for Division B$,$ within the same company. In the next period,

Division B anticipates a requirement for $10000$ units of the component. The component is currently

purchased from Division A at a transfer price based on full cost.

At the expected level of demand, the costs of Division A supplying the component to Division B in the

next period are expected to be:

$$ Variable costs N$$3\mathrm{.}70$ per unit

$$ Fixed costs N$$18000$ for the period.

Division A would like to change the basis for the calculation of the transfer price of the component in

order to make a profit. However, an increase in the transfer price is being resisted by Division B$,$

especially as the component is also available from a supplier outside the company at a cost price of

N$$5\mathrm{.}20$ per unit.

Required

Marks

Comment on the use of $$full cost plus$$ and $$marginal cost$$ as the basis for

$1\mathrm{.}1$

transfer pricing.

Note: Students will be penalised for copying and pasting information

from the internet without analysis.

$1\mathrm{.}2$ Calculate the transfer price for the component for the next period if based on

full cost.

$6$

$3$

$1\mathrm{.}3$ Calculate whether the company would gain or lose in the period if Division B

$1\mathrm{.}4$

purchased the component entirely from the outside supplier.

Assume that purchase of the component, by Division B$,$ entirely from the

outside supplier would release capacity in Division A$.$ This surplus capacity

could be used to generate a contribution of N$$20000$ in the period on another

component. Determine the effect on group profit, and the effect on the profit of

each of the two divisions, in these circumstances.

$5$

$6$

Total

$20$

Question $2$

$(30$ marks$)$

ABC company is considering the introduction Product A which is a new product in the market. The

introduction would require an investment of N$$100000$ in new manufacturing equipment. The product

would have a selling price of N$$60$ per unit and a contribution margin of $42\%.$ No changes in either selling

prices or variable cost prices are anticipated over the five$-$year life of the investment.

Market research indicates the following probabilities relating to demand for the new product in the first

year:

Sales units

$7000$

$8000$

$9000$

$10000$

Sales volume would be expected to grow at a rate of $10\%$ per annum.

Probability

$10\%$

$30\%$

$45\%$

$15\%$

Incremental fixed costs resulting from the investment are estimated at N$$225000$ per annum,

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FACULTY OF COMMERCE, MANAGEMENT AND LAW

OLD CURRICULUM MODULES

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increasing to N$$250000$ per annum in years $4$ and $5.$ The investment would be expected to have a

terminal value of N$$5000$ at the end of its five$-$year life. The cost of capital is $10\%$ per annum.

Discount factors at $10\%$ are:

Year $10\mathrm{.}909$

Year $20\mathrm{.}826$

Year $30\mathrm{.}751$

Year $40\mathrm{.}683$

Year $50\mathrm{.}621$

Required Marks

$2\mathrm{.}1$ Calculate the expected sales value of the new product for each of the

five years. $5$

$2\mathrm{.}2$ Calculate the expected net present value of the new product

investment opportunity. $10$

$2\mathrm{.}3$

Calculate an approximate internal rate of return for the investment $($to

the nearest percentage$)$ using the net present values at $0\%($i$.$e$.$

undiscounted$)$ and $10\%.$

$5$

$2\mathrm{.}4$ Calculate the sensitivity of the project to change in cost of capital,

selling price, sales volume, fixed costs and variable costs. $10$

Total $30$