Theraband Ltd. has three divisions (Entertainment, Plastics, and Electronics), each of which is considered an investment center for performance-evaluation purposes. The Entertainment Division manufactures childrens toys using products produced by the other two divisions, as follows:

1. The Entertainment Division purchases plastic components from the Plastics Division that are considered unique (i.e., they are made exclusively for the Entertainment Division). In addition, the Plastics Division makes less-complex plastic components that it sells externally, to other producers.

2. The Entertainment Division purchases, for each unit it produces, an electronic controller from Theraband's Electronics Division, which also sells this electronic controllers externally (to other producers).

The per-unit manufacturing costs associated with each of the above two items, as incurred by the Plastic Components Division and the Electronics Division, respectively, are:

	Plastics	Electronics
Direct material	Rs.125	Rs.240
Direct labor	235	300
Variable overhead	100	150
Fixed overhead	40	225
Total cost	Rs.500	Rs.915

The Plastics Division sells its commercial products at full cost plus a 25% markup and believes the proprietary plastic component made for the Entertainment Division would sell for Rs.625/unit on the open market. The market price of the Electronics used by the Entertainment Division is Rs.1,098/unit.

1. In each of the following mutually exclusive scenarios, please briefly explain, the impact (not necessarily monetary impact, but behavioral as well) of the transfer pricing arrangement on the company as a whole and each of its affected divisions. NO CALCulations

(a) A per-unit transfer price from the Electronics Division to the Entertainment Division at full cost of Rs.915,

(b) Entertainment Division is able to purchase a large quantity of electronic controllers from an outside source at Rs.870/unit. The Electronics Division, having excess capacity, agrees to lower its transfer price to Rs.870/unit.

c) Plastics Division has excess capacity and it has negotiated a transfer price of Rs.560 per plastic component with the Entertainment Division.

2. Transfer pricing may convert fixed organizational costs into variable costs thus making an organization uncompetitive. Do you agree?