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Good morning John
I m confused by some answers.
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1. Cherry’s transfer pricing system should seek to establish a transfer price for X that will provide an incentive for the managers of A and B to make and sell quantities of products that will maximise sales of Product Y —- i said true because my thinking is if they sell more, thats better for the company but the answer is false. Why is that?
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2. In a competitive market, it is likely that suppliers will offer product X to divisionB significantly cheaper than Division A can, for a sustained period of time —- i said true, however, the explanation says that it is false because Division A is likely to save money on selling and distribution expenses if they can sell product to X to division B.My question is, what if variable costs for division A are higher than the purchasing price from external market, therefore TP would be also higher than the external price? B would then go and buy externally instead.
Please kindly advise
1. The objective is indeed to maximise profit, but the profit for the company is not just coming from sales of Y (which also depends on where they get product X from) but also from any sales of X externally. So the transfer price needs to be determined so as to take all factors into account – not simply maximising the number of Y’s that are sold.
2. Yes – as I explain in the lectures, the most B will pay is the lower of the net marginal revenue and any external purchase price. If the external purchase prices was lower than the transfer price they would buy externally.
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