Question 1
a) Three factors are as following.
 Fact that good quality leather was in short supply and hence a backup was
required.
 Ensure that the leather tanning division was competitive as the show
division had the choice to purchase from external vendor if it was
available cheaper.
 Ensure that leather tanning division takes step to maximise generation of
profit by lowering costs and improving efficiency.
b) If there is enough spare capacity available, then it makes sense to buy from
tannery division inhouse. This is because it would result in greater capacity
utilisation of the division and also would ensure that there are cost savings in
production.
Outside acquisition price = 0.85*$7.5 = $6.38
Variable cost if procured inhouse = 2 + 1+ 0.8 + 0.8 + 0.3 + 0.3 = $ 5.2
Clearly in case of additional production when spare capacity is there, no
incremental fixed costs are incurred. Hence, it is correct to conclude that
incremental cost for inhouse sale is $ 5.2 per unit which is lower than $6.38
offered from outside. Hence, optimal decision is to source inhouse.
c) This is not an appropriate transfer price. This is because of the following
reasons.
 By selling inhouse, the tanning division can save two thirds of the
variable selling and administrative cost and half of the variable
manufacturing cost. This is significant saving for the company which
needs to be reflected in the selling price.
 Additionally, it is incorrect on the part of the tanning division to look to
maximise its divisional profits without taking the interest of the company
as a whole. It should charge a lower price when supplying internally as
the costs are lower.
 At the current price of $ 7.5, it is likely that Shoe division would purchase
from outside since an additional 15% discount is available. As a result,
the potential cost savings which the division could realise by supplying
internally would be lost. This would not be in the best interest of the
company.
d) Minimum transfer price = total cost incurred for inhouse selling = 2+1+0.8+
0.8+0.3 + 1 + 0.6 = $6.5 per unit
Maximum transfer price = $7.5 per unit (Existing market price)
e) If going forward, the tannery division does not have spare capacity, then the
optimal sourcing decision would be that shoe division should procure from

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