20. DIVISION K
Division K, which is a part of the JKL Group, manufactures only one type of product, a Bit, which it sells to external customers and also to division H, another member of the group. JKL Group's policy is that divisions have the freedom to set transfer prices and choose their suppliers.
The JKL Group uses residual income (RI) to assess divisional performance and each year it sets each division a target RI. The group's cost of capital is 12% a year.
Budgeted information for the coming year is:
Maximum capacity 150,000 Bits
External sales 110,000 Bits
External selling price $35 per Bit
Variable cost $22 per Bit
Fixed costs $1,080,000
Capital employed $3,200,000
Target residual income $180,000
Division H has found two other companies willing to supply Bits:
A could supply at $28 per Bit, but only for annual orders in excess of 50,000 Bits. B could supply at $33 per Bit for any quantity ordered.
A. Division H provisionally requests a quotation for 60,000 Bits from division K for the coming year.
i) Calculate the transfer price per Bit that division K should quote in order to meet its residual income target.
ii) Calculate the two prices division K would have to quote to division H, if it became group policy to quote transfer prices based on opportunity costs.
B. Discuss, with supporting calculations, the impact of the group's current and proposed policies on the profits of divisions K and H, and on group profit.