QUESTION 1 Lemon Ltd has been offered supplies of special ingredient Z at a transfer price of R15 per kg by Zest Ltd which is part of the same group of companies. Zest Ltd processes and sells special ingredient Z to customers external to the group at R15 per kg. Zest Ltd bases its transfer price on cost plus 25% profit mark-up. Total cost has been estimated as 75% variable and 25% fixed. REQUIRED: 1.1. Explain what the objectives of transfer pricing are. (3) 1.2. Discuss the transfer prices at which Zest Ltd should offer to transfer special ingredient Z to Lemon Ltd in order that group profit maximising decisions may be taken on financial grounds in each of the following situations: 1.2.1. Zest Ltd has an external market for all of its production of special ingredient Z. at a selling price of R15 per kg. Internal transfers to Lemon Ltd would enable R1.50 per kg of variable packing cost to be avoided. (6) 1.2.2. Conditions are as per (1.1) but Zest Ltd has a production capacity of 3000kg of special ingredient Z, for which no external market is available. (2) 1.2.3. Conditions as per (1.2), but Zest Ltd has an alternative use for some of its spare production capacity. This alternative use is equivalent to 2000kg of special ingredient Z and would earn a contribution of R6000