Bounce Ltd is a leading manufacturer and retailer of one type ofproduct, ProdX. It has divided its operations into three divisionsi.e.

Division A: Supply rubber

Division B: Compound rubber with chemicals to produce finishedrubber

Division C: Produce ProdX

Division B has offered to buy 65,000 meters of rubber per annumfrom Division A at a price of £45 per meter. Although the totalcapacity of the Division A is 135,000 meters per annum, its normalproduction levels are 118,000 meters per annum. The productioncosts per meter (under normal production of 118,000 meters) ofrubber are as follows:

Direct material: £17

Direct labour:     £13

Variable overhead: £6

Fixed overhead (i.e. total fixed overheads/118,000): £16

Total: £53

Division A has been selling its finished products i.e. rubber tooutside buyers at £62 per meter. Division B has been buying rubberfrom outside suppliers at £59 per meter.

Required:

a) Presuming each divisional manager aims to optimize theirdivision’s financial performance; discuss with reason(s) whetherthe manager of Division A will accept a purchase offer of £45 permeter. Calculate the financial implication of accepting orrejecting the offer on Division A.

b. Will the internal transfer result in the financial gain orloss for the company? Explain the reason(s) behind this gain orloss. Calculate the financial implication of the internal transferon Bounce Ltd.

Note: For (a) and (b) above, please use numerical evidence tojustify your answer.

c. If division A loses its excess capacity, show with reasons,the maximum transfer price Division B would be willing to pay andthe minimum transfer price Division A would be willing toaccept.

d. If Division A loses its excess capacity, will Bounce Ltdbenefit from future internal transfers?

Division C of Bounce Ltd currently purchases a fixed quantityfinished rubber from Division B for £76 per meter. The manager ofDivision B is considering the prospects of raising the prices ofthe finished rubber from £76 to £90 per meter; a proposal which isstrongly opposed by Division C. Division C is able to purchasefinished rubber at £80 per meter in the open market. The cost ofproduction per meter in the Division B is as follows:

Direct materials: £47 (Includes £44 paid to Division A + otherdirect materials)

Direct labour: £15

Variable overhead: £4

Fixed overhead per meter: £12

Total: £78

If Division B stopped supplying rubber to Division C, they willbe able to save one-fourth of the fixed overheads per meter.Currently, Division B does not have any alternative use for itsspare capacity.

Required:

1. Calculate the maximum transfer price Division C would bewilling to pay and the minimum transfer price Division B would bewilling to accept.
2. From the perspective of Bounce Ltd, examine whether Division Cshould purchase steel from Division B or if it should purchase fromthe open market.