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This is an Mcq taken from BPP revision kit (#69.4) on transfer pricing.
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In a company with divisionalized structure, Div A transfers its output to Div B. Div A produces just 1 item, component X. Div makes & sells end product that requires 1 unit of component X.Marginal Cost Div. A $8
Fixed O/H $3
Market Price $16
Div B contribution $25 (frm further processing, before deducting transfer cost)Div A is not working at full capacity & can meet internal/external demand.
What should the minimum & maximum transfer price?
Correct Ans: min $8; max $25.
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I dont get the maximum transfer part. Although I do understand that since Div A has spare capacity, the minimum transfer price it will be willing to offer B would be at the marginal cost i.e. $8/unit. But how can the maximum transfer price be $25, when the external market price is $16. In other words, why would Div B be willing to buy from Div A at above $16, if it can get it from the external market at that price. Therefore, my answer was: min $11 max $16.
Please comment/helpThis is very poor of BPP.
When they give the market price in the external market, they are intending this to be the price that A can sell in the external market (and not the price that B can buy in the external market). However, they have not made that clear. If B can buy in the external market then your answer would indeed be correct.
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