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AA and BB are two divisions of the ZZ group

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January 7th, 2018

AA and BB are two divisions of the ZZ group. The AA division manufactures electrical components which it sells to other divisions and external customers.The BB division has designed a new product, Product B, and has asked AA to supply the electrical component, Component A, that is needed in the new product. This will be a completely new style of component. Each unit of Product B will require one Component A. This component will not be sold by AA to external customers. AA has quoted a transfer price to BB of $45 for each unit of Component A.It is the policy of the ZZ group to reward managers based on their individual division’s return on capital employed.Details of the monthly production for each division are as follows:AA divisionOutputComponent A will be produced in batches of 1,000 units. The maximum capacity is 6,000 components per month.Variable cost$15 per componentFixed costs$50,000 (these are incurred specifically to produce Component A)BB divisionOutput Product B will be produced in batches of 1,000 units. The maximum customer demand is 6,000 units of Product B per month.Variable cost$9 per unit plus the cost of Component AFixed costs$75,000 (these are incurred specifically to produce Product B)The relationship between monthly customer demand and the selling price of Product B is shown below:DemandSelling price per unit1,000 units$1202,000 units$1103,000 units$1004,000 units$905,000 units$806,000 units$67Required:(a) Calculate, based on a transfer price of $45 per Component A, the monthly profit that would be earned as a result of selling Product B by:(i) BB division(ii) AA division(iii) ZZ group(9 marks)(b) Calculate the maximum monthly profit from the sale of Product B for the ZZ group.(4 marks)(c) Calculate, using the marginal cost of Component A as the transfer price, the monthly profit that would be earned as a result of selling Product B by:(i) BB division(ii) AA division(iii) ZZ group(5 marks)(d) Discuss, using the above scenario, the problems of setting a transfer price and suggest a transfer pricing policy that would help the ZZ group to overcome the transfer pricing problems that it faces.(7 marks)(Total for Question Seven = 25 marks)

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