OIL BEST Company has two divisions which are processing and refinery. The processing
division produces 500 tonnes of product "Mild Oil" from 1000 tonnes of raw materials per month. Meanwhile, refinery division produces 300 tonnes of product "Purified Oil" from 500 tonnes of "Mild Oil" received from processing division. The cost data are as follows:-
Raw materials Tsh. 1,200,000 per tonne
Variable costs Tsh. 800,000 per tonne of output
Fixed costs Tsh. 50,000,000 per month
Variable costs Tsh. 300,000 per tonne of output
Fixed costs Tsh. 21,000,000 per month
The market prices of "Mild Oil" and "Purified Oil" are Tsh. 5,000,000 per tonne and Tsh. 12,000,000 per tonne respectively.
i) Compute the overall profit of the company per month
ii) Compute the minimum Transfer Price per tonne the processing division will be willing to sell to the refinery division while assuming the processing division is working at its fully capacity and there is external market for the mild oil.
iii) Compute the minimum transfer price per tonne the processing division will be willing to sell to the refinery division while assuming that the processing division can meet the demand of the refinery division without altering external demand.
iv) Identify the maximum transfer price the buying division will be willing to pay to the processing division and comment on whether there is any chance for the managers of the two divisions to negotiate the transfer price while considering the minimum transfer price in iii) above.
v) Provide two reasons as to why a company may have to use transfer price when intermediate products are moving within divisions of the same company