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ACCA Strategic Professional · Advanced Performance Management · Performance optimisation in specific contexts

Division P of Brandt Group makes a component and transfers it to Division Q. P has spare capacity. The variable cost is $30, the external market price is $50 and Q can buy externally at $50. The group wants decisions that maximise group profit, and Q's manager is rewarded on divisional profit. Which transfer price is most likely to produce the optimal group decision, and why?

A transfer price of $30 is best because P has spare capacity, so the minimum price equals variable cost with no opportunity cost. This encourages Q to buy internally whenever it benefits the group. A price above $50 would wrongly drive Q to the external market.

  1. A$30, the marginal cost, because with spare capacity there is no opportunity cost and Q will buy internallyCorrect
  2. B$50, the market price, because it always gives the optimal group outcome
  3. C$40, a negotiated midpoint, because any price between $30 and $50 is zero-sum
  4. D$60, cost plus 100%, because it guarantees P's profit

Explanation

With spare capacity, the minimum transfer price is variable cost plus opportunity cost of zero, which is $30. Setting it at $30 ensures Q buys internally whenever that is cheaper for the group. A $50 price is optimal only when P is at full capacity; $60 would push Q to buy externally at $50, harming the group.

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