QUESTION 3: TRANSFER PRICING.

Quest Motors Ltd operates as a decentralized multidivisional company. The Vivo Division of Quest Motors purchases most of its airbags from the Airbag Division. The Airbag Division's incremental cost for manufacturing the airbags is $90 per unit. The Airbag Division is currently working at 80% of capacity. The current market price of the airbags is $125 per unit.

REQUIRED:

1.Using the general formula, what is the minimum price at which the Airbag Division would sell airbags to the Vivo Division?(3 marks)

2.Suppose that Quest Motors requires that whenever divisions with unused capacity sell products internally, they must do so at the incremental cost. Evaluate this transfer-pricing policy using the criteria of goal congruence, evaluating divisional performance, motivating management effort and preserving divisional autonomy.(4 marks)

3.(i) If the two divisions were to negotiate a transfer price, what is the range of possible transfer prices?(2 marks)

(ii)Briefly explain how a transfer price is set using negotiation.(3 marks)

4.Instead of allowing negotiation, suppose that Quest specifies a hybrid transfer price that 'splits the difference' between the minimum and maximum prices from the division's standpoint. What would be the resulting transfer price of airbags?(3 marks)