QUESTION THREE

Tomato beetles, a major pest to the tomato crop, are now being controlled by toxic pesticides. The firm bioscience invested Sh. 5 million in R & D over the last five years to produce a genetically engineered, patented microbe, MK-23, which controls tomato beetles in an environmentally safe way. Bioscience built a plant with capacity to produce 10,000 kilograms of MK-23 per month. The plant cost sh. 12 million and has a 10 year life. MK-23 has a variable cost of sh. 3 per kilogram. Fixed costs are sh. 50,000 per month for such costs as plant management, insurance, taxes and security. Plant depreciation is not included in the sh. 50,000 fixed cost.

The following table summarizes the full cost of producing MK-23

	Shs.
Depreciation per month (12,000,000/120 months)	100,000
Other fixed costs	50,000
Total fixed costs	150,000
Divide by capacity per month (kilograms)	10,000
Fixed cost per unit of capacity (kilograms)	15.00
Variable costs per kilogram	3.00
Full cost per kilogram	18.00

MK-23 is sold for sh. 30 per kilogram. Bioscience is currently selling 8000 kilograms per month to tomato farmers.

Another division of Bioscience, Home Life, wants to secure 1,000 kilograms per month of MK-23 that it will process further into a consumer product, Tomato safe, for gardeners. Home life is willing to pay an internal transfer price of sh. 5 per kilogram. Home Life will incur an additional sh. 4 of variable cost per kilograms of MK-23 in packaging and reducing the potency of MK-23 to make Tomato Safe more appropriate for home gardeners. Tomato Safe will sell for sh. 20 per kilogram of MK-23.

Required

1. Should the internal transfer be allowed? ( 9 marks)
2. What happens if the transfer right is set at full cost, sh. 18? What happens if the transfer price is set at variable cost, sh. 3?
3. After deciding to use variable cost as the transfer price, new farm orders for 2,000 kilograms of MK-23 at sh. 30 per kilograms per month are received. Suppose plants come only in fixed sizes of 10,000 kilograms capacities of sh.1 2million each. Analyze the various options facing bioscience (7 marks)
4. What is the opportunity cost of the excess capacity prior to producing MK-23 for Tomato Safe? (2 marks)
5. What happened to the sh. 5 million R & D costs incurred to invent MK-23? ( 2 marks)