Transfer Pricing in the Presence of Divisional Interdependencies

question 6

Essay

Transfer Pricing in the Presence of Divisional Interdependencies
Prior to 1997,PepsiCo,a major soft drink company,had a restaurant division consisting of Kentucky Fried Chicken,Taco Bell,and Pizza Hut.The only cola beverage these restaurants served was Pepsi.Assume that the major reason PepsiCo owned fast food restaurants is an attempt to increase its share of the cola market.Under this assumption,some Pizza Hut patrons who order a cola at the restaurant and are told they are drinking a Pepsi will switch and become Pepsi drinkers instead of Coke drinkers on other purchase occasions.However,studies have shown that some customers refuse to eat at restaurants unless they can get a Coke.
PepsiCo sells Pepsi Cola to non-PepsiCo restaurants at $0.53 per gallon.This is the market price of Pepsi-Cola.Pepsi-Cola's variable manufacturing cost is $0.09 per gallon and its total (fixed and variable)manufacturing cost is $0.22 per gallon.PepsiCo produces Pepsi-Cola in numerous plants located around the world.Plant capacity can be added in small increments (e.g. ,a half-million gallons per year).The cost of additional capacity is approximately equal to the fixed costs per gallon of $0.13.
Required:
What transfer price should be set for Pepsi transferred from the soft drink division of PepsiCo to a PepsiCo restaurant such as Taco Bell? Justify your answer.

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Definitions:

Amoebozoa

Members of the unikont clade characterized by lobose pseudopodia at some time in the life cycle; include amoebas, plasmodial slime molds, and cellular slime molds. Compare with opisthokonts.

Unicellular

Describes organisms made up of a single cell, which performs all necessary functions for life, such as bacteria and some algae.

Stramenopiles

A diverse group of eukaryotic organisms, including diatoms and brown algae, characterized by fine, hair-like structures on their flagella.

Biflagellate

Having two flagella, which are long, slender projections that provide locomotion to various cells and single-celled organisms.