QUESTION 1

The AEDI Company (Pty) Ltd manufactures a range of genetically modified pesticides
that are environmentally safe. One of its divisions, namely Division A, produces a
product called MK-23 that is a safe pesticide for tomato farmers.
Budgeted Data
Unit Financial Data for MK-23 R/unit
Selling price per kilogram R 30
Variable cost per kilogram R3

A second division, namely Division B, has indicated that it could use some of the spare
capacity of Division A. In this regard, Division B has indicated that it can modify MK-23
to produce a home based pesticide sold in powder form. In order to do this, further
conversion costs of R 4 per kilogram are required. Division B estimates that it can sell
this product for R20 per kilogram to urban based families. This home pesticide,
however, will compete with other brands on the market and initial surveys by the
marketing department indicate that the product is price sensitive.

The sales division estimated the demand for the home pesticide at two different selling
prices:
Selling Price: R 22 R20
Demand (Kg): 100 000 150 000

You are required to:

(a) Calculate the range of transfer prices, for one kilogram of MK-23, that would
motivate both divisions to transfer and receive the optimum quantity of Division A’s
spare capacity of MK-23, from a company perspective.
(12 Marks)
(b) Calculate the EVA of Division A both before and after the transaction with Division B
and briefly comment on the difference. Use the transfer price calculate in a).
Consider the long term implications of this supply relationship for Division A.
(13 Marks)
(Total Question: 25 Marks/60 Minutes)
(Management Accounting and Finance IV: November Exam 2008)
QUESTION 2 (45 Marks)

The New World Manufacturing Company (Pty) Ltd (NWC) has a wide range of
manufacturing activities, principally within Gauteng. You are the financial manager of
NWC and the CEO has asked you to investigate a transfer pricing problem involving two
divisions, namely, Division A and Division B that are located in Germiston. Both
divisions are involved in a wide range of activities. Division A makes an electric motor,
the Z80, which it has been selling to external customers at R 1350 per unit. Division B
wanted to buy Z80 motors to use in it’s own production of vacuum cleaners; each
vacuum cleaner requires one motor. Division A is only prepared to sell to Division B at a
price of R 1350 per motor.

The managing director of Division A commented:

‘We have developed a good market for this motor and R 1350 is the current market
price. Just because Division B is not efficient enough to make a profit is no reason for
us to give them a subsidy’. From information supplied by the divisions you have
derived the following production and revenue schedules which are applicable over the
capacity range of the two divisions. The external market for the Z80 and the sale of
vacuum cleaners operate in imperfect market conditions.
DIV A DIV A DIV A DIV B DIV B
Annual Total Total Revenue Total Production Total revenue
units Manufacturing Outside Sales cost of vacuum from sales of
Cost of Z80 cleaners excluding vacuum
(R 000) (R 000) the cost of Z80 cleaners
(R 000) (R 000)
100 115 204 570 703
200 185 362 1120 1375
300 261 486 1670 2036
400 344 598 2220 2676
500 435 703 2770 3305
600 535 803 3320 3923
700 645 898 3870 4530
800 766 988 4420 5126
You are required to:
(a) Ignoring the possibility that Division B could buy motors from another manufacturer,
calculate to the nearest 100 units:
i) the quantity of Z80 production that would maximize profits for the NWC company
as a whole and
ii) the consequent quantity of Z80 motors that would be sold to external
customers and the quantity that would be transferred to Division B.
(20 Marks)

(b) Calculate the optimal range of transfer prices for the company and select a transfer
price within this range to calculate the net profit of the two divisions. Explain why you
have selected this transfer price for your calculations. (10 Marks)

(c) Identify and explain the problems of transfer pricing that arise between the two
divisions, and the impact on production decisions if the optimal transfer price range
was not used. Discuss the advantages and disadvantages of the courses of action
which can be taken. (Where possible, use calculations to support your answer).
(15 Marks)

(Total Question: 45 Marks/67.5 Minutes)

(Management Accounting and Finance: November Exam 2006)
QUESTION 3 (35 Marks)

The Sabie River Company, located in Mpumalanga, manufactures and sells chemical
compounds that form inputs for the pharmaceutical industry. The company has been in
operation for a number of years and has a reputation as a reliable supplier. In recent
times transport costs to Gauteng have increased significantly as a result of the
increased toll fees on the N4 highway and the increasing cost of fuel. The company’s
management is conservative and have invested considerable past earnings in
government bonds. Management, however, is worried about the long term position of
the company as the raw material supply of its compounds is increasingly difficult to
obtain.

In recent times the pharmaceutical industry has changed considerably. New entrants
like Genentec have revolutionised research and development technology to bring a new
class of drugs onto the market at much lower levels of cost. The managing director has
suggested that once internal capacity has been optimised the company should rethink
the future

Interdivisional Trading
The Sabie River Company has four divisions, namely, A, B, C and D. Divisions B, C
and D are organised as profit divisions whilst Division A is classified as a cost centre.
Division A processes a raw material to provide an input to Division B. Division B further
processes these inputs and converts them to a basic chemical compound called (B4H).
Currently there is no intermediate market for B4H but Division B has been set up as a
profit centre in order to motivate the divisional management. Division B sells B4H to
Divisions C and D that further process this input to produce Bayon and Calamite
respectively. These products are sold in an external market in the pharmaceutical
sector. Both products are price sensitive. The variable cost structure for Divisions A and
B are on the following page:
Cost Element DIV A DIV B
R R
Raw Material per Kg 0.05
Direct Cost per Kg: Bought in 0.02
Variable Overhead per Kg 0.05 0.04
Transport cost per Kg 0.02

Division B has a capacity limit of 10 000 kilograms whilst divisions C and D have
capacity limits of 4 000 kilograms and 6 000 kilograms respectively. Given the high
cost of storing B4H, Bayon and Calamite, Sabie River divisions produce no more than
the quantities they plan to sell. Divisions C and D sell Bayon and Calamite in separate
markets.

The total revenues and additional processing costs (excluding the costs of B4H)
for the two divisions are as follows:
DIVISION C:
Kilograms of B4H Total Cost Total Revenue
Processed (R) (R)
1000 1000 1500
2000 1900 2950
3000 3000 4350
4000 4200 5700

DIVISION D:
Kilograms of B4H Total Cost Total Revenue
Processed (R) (R)
1000 2000 2600
2000 3800 5100
3000 5650 7550
4000 7700 9950
5000 9900 12300
6000 12300 14600
You are required to:
(a) Determine what quantity of B4H Division B should produce in order to maximise the
profitability of the Sabie River Company. Also indicate how this quantity should be
allocated to divisions C and D. If Division A could reduce variable cost per unit by
40% how would this affect the decisions of Divisions C & D? (Marks 15)

(b) From a motivation and performance evaluation perspective determine the range of
transfer prices that would motivate divisions C and D to purchase the required
quantities of B4H that would maximise Sabie River profitability determined in a)
above, as well as motivate Division B. Calculate ranges for the current cost
structure, as well as for where the cost reduction in Division A has taken place.
(Marks 10)

(c) Discuss some of the options that Sabie River Company could consider with respect
to the optimal long term positioning of the company in the pharmaceutical industry.
(Marks 10)

(Total Question: 35 Marks/52.5 Minutes)

(Management Accounting and Finance: June Exam 2003)