4 The Better Agriculture Group (BAG), which has a divisional structure, produces a range of products for the farming
industry. Divisions B and C are two of its divisions. Division B sells a fertiliser product (BF) to customers external to
BAG. Division C produces a chemical (CC) which it could transfer to Division B for use in the manufacture of its
product BF. However, Division C could also sell some of its output of chemical CC to external customers of BAG.
An independent external supplier to The Better Agriculture Group has offered to supply Division B with a chemical
which is equivalent to component CC. The independent supplier has a maximum spare capacity of 60,000 kilograms
of the chemical which it is willing to make available (in total or in part) to Division B at a special price of $55 per
kilogram.
Forecast information for the forthcoming period is as follows:
Division B:
Production and sales of 360,000 litres of BF at a selling price of $120 per litre.
Variable conversion costs of BF will amount to $15 per litre.
Fixed costs are estimated at $18,000,000.
Chemical (CC) is used at the rate of 1 kilogram of CC per 4 litres of product BF.
Division C:
Total production capacity of 100,000 kilograms of chemical CC.
Variable costs will be $50 per kilogram of CC.
Fixed costs are estimated at $2,000,000.
Market research suggests that external customers of BAG are willing to take up sales of 40,000 kilograms of CC at a
price of $105 per kilogram. The remaining 60,000 kilograms of CC could be transferred to Division B for use in
product BF. Currently no other market external to BAG is available for the 60,000 kilograms of CC.
Required:
(a) (i) State the price/prices per kilogram at which Division C should offer to transfer chemical CC to Division
B in order that the maximisation of BAG profit would occur if Division B management implement rational
sourcing decisions based on purely financial grounds.
Note: you should explain the basis on which Division B would make its decision using the information
available, incorporating details of all relevant calculations. (6 marks)