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For example if the marginal cost of a transferred item is $5 and it has an external intermediate market
of $7 but external selling costs of $0.50; and if the transferring-in division can use the transferred
item to make an end product that earns a contribution of $10, the maximum transfer price should be
the lower of $7 and $10. The minimum transfer price should be $5 + $(7 – 5 – 0.50) = $6.50.1) when they haven’t said anything about limited production capacity, then why are we adding contribution in the minimum transfer price?
2) why is the maximum price lower of 7 and 10?
If you have typed out the whole question correctly, then it is a very poor question.
If it is a past exam question, or from the BPP Revision Kit, then please tell me which question so I can check for myself.
1. They have assumed that there is unlimited demand in the external market, so that everything they produce could be sold externally. If that is the case then the answer is correct. However the question should give information about this.
2. The answer to the maximum price is nonsense. As you will know from my free lectures, the maximum price is the lower of the net marginal revenue (which we do not know here, but is certainly not the contribution of 10) and any external purchase price (the answer has assumed they can buy for 7 because the other division can sell for 7, but we cannot assume that unless we are told that is the case).
Please do tell me where you found this question 🙂
I think maybe you are using an old edition of the Revision Kit, because question 213 in the current edition is nothing to do with transfer pricing. I. have looked through all of the transfer pricing questions in the current edition and cannot find one with the numbers you quote in it.
However, assuming you have copied everything correctly, then my previous reply still stands! 🙂
Yes I have the 2016-2017 edition.
Is that edition ok for June 18 exam or should I buy a new one?
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