Reference no: EM133077910

Question - Escuelas SA has two divisions. The Mining Division makes toldine, which is then transferred to the Metals Division. The toldine is further processed by the Metals Division and is sold to customers at a price of £150 per unit. The Mining Division is currently required by Escuelas to transfer its total yearly output of 400 000 units of toldine to the Metals Division at 110% of full manufacturing cost. Unlimited quantities of toldine can be purchased and sold on the outside market at £90 per unit. To sell the toldine it produces at £90 per unit on the outside market, the Mining Division would have to incur variable marketing and distribution costs of £5 per unit. Similarly, if the Metals Division purchased toldine from the outside market, it would have to incur variable purchasing costs of £3 per unit.

The following table gives the manufacturing costs per unit in the Mining and Metals Divisions for the year 2005:

¹Manufacturing overhead costs in the Mining Division are 25% fixed and 75% variable.

²Manufacturing overhead costs in the Metals Division are 60% fixed and 40% variable.

	Mining Division	Metals Division
	£	£
Direct materials	12	6
Direct labour	16	20
Manufacturing overhead	32¹	25²
Manufacturing costs per unit	60	51

Required -

a) Calculate the operating profits for the Mining and Metals Divisions for the 400 000 units of toldine transferred under each of the following transfer-pricing methods: market price, and 110% of full manufacturing cost.

b) Suppose Escuelas rewards each division manager with a bonus, calculated as 1% of divisional operating profit (if positive). What is the amount of bonus that will be paid to each division manager under each of the transfer-pricing methods in requirement (1) above? Which transfer-pricing method will each divisional manager prefer to use?

c) What arguments would Arturo Tuzon, manager of the Mining Division, make to support the transfer-pricing method that he prefers?

d) From the standpoint of Escuelas SA as a whole, what quantity of toldine should the Mining Division transfer to the Metals Division?

e) Now suppose each division manager acts autonomously to maximise the division's operating profit. What range of transfer prices will result in managers of the Metals and Mining Divisions achieving the actions determined to be optimal in requirement (1)? Explain your answer.

f) Would you recommend that Escuelas allow the divisions to buy and sell toldine in the open market, and to negotiate transfer prices between themselves? Explain your answer.