Reference no: EM133113735

Question - Baroque Beverages (BB) produces and sells fruit drinks. Production is done in two stages: (1) fresh fruit is processed into juice concentrate and (2) juice concentrate is processed into the final beverage. Currently, BB has one factory that can process 7,500 units of juice concentrate and 10,000 units of the final beverage (one unit of juice concentrate is required to make one unit of the final beverage). Expected per unit manufacturing costs, based on production of 7,500 units, in the two stages are as follows:

For the upcoming fiscal year, Ferenc Deák (the divisional manager of BB) expects demand to be for 10,000 units of the final beverage at a price of £750/unit; however he is constrained to selling only 7,500 units (and therefore only expects to produce 7,500 units of both the juice concentrate and the final beverage). Additionally, he expects to incur £1,175,000 in fixed non-manufacturing costs and £750,000 in corporate overhead charges. This charge is meant to ensure that Ferenc's division pays for its usage of corporate services (including general marketing, legal and R&D). When Ferenc enquired as to the rationale for the amount of the allocation, he was told that it was because his division was one of the largest divisions of the company.

Ferenc is paid a bonus of 3% of BB residual income (but before bonus payment) and 1% of the corporate residual income (but before bonus payments); corporate profit is forecasted to be £1,890,000. The capital invested in BB is equal to £3,000,000 and the capital invested in the company as a whole is equal to £12,000,000. The corporate wide cost of capital is 10%.

a. Calculate Ferenc's expected bonus for the next fiscal year.

Ferenc has been approached by Irina Spalko - manager of Mamadou (another division within the same company) - who wants to supply BB with 10,000 units of juice concentrate (in an all-or-nothing transaction). Ferenc knows that the decentralized structure of the organisation means that he can decide whether to accept the offer, without interference from the head office. Ferenc also knows that if he accepts the offer, then the factory space dedicated to producing juice concentrate will sit idle.

b. Calculate the maximum transfer price that Ferenc would be willing to pay per unit to Mamadou for 10,000 units of juice concentrate to ensure that BB profit remains unchanged. (Note: the budgeted corporate charge will remain at £750,000).