(a) An optimal transfer price (or range of transfer prices) is a price for an internally-transferred item at which:

• the selling division will want to sell units to the other profit centre, because this will add to its divisional profit
• the buying division will want to buy units from the other profit centre, because this will add to its divisional profit
• the internal transfer will be in the best interests of the entity as a whole, because it will help to maximise its total profit.

  (b) When Division X has spare capacity, its only cost in making and selling extra units of Product B is the variable cost per unit of production, GH₵48. Division Y can buy the product from an external supplier for GH₵55. It follows that a transfer price that is higher than GH₵48 but lower than GH₵55, for additional units of production, will benefit both profit centres as well as the company as a whole. (It is in the best interests of the company to make the units in Division X at a cost of GH₵48 than to buy them externally for GH₵55.

  (c) When Division X is operating at full capacity and has unsatisfied external demand for Product A, it has an opportunity cost if it makes Product B for transfer to Division Y. Product A earns a contribution of GH₵16 per unit (GH₵62 – GH₵46). The minimum transfer price that it would require for Product B is:

   

  	GH₵
  Variable cost of production of Product B	48
  Opportunity cost: lost contribution from sale of Product A	16
  Minimum transfer price to satisfy Division X management	64

  Division Y can buy the product from an external supplier for GH₵55, and will not want to buy from Division X at a price of GH₵64. The maximum price it will want to pay is GH₵55.
  The company as a whole will benefit if Division X makes and sells Product A.
  It makes a contribution of GH₵16 from each unit of Product A.
  If Division X were to make and sell Product B, the company would benefit by only GH₵7. This is the difference in the cost of making the product in Division X (GH₵48) and the cost of buying it externally (GH₵55).
  The same quantity of limited resources (direct labour in Division X) is needed for each product, therefore the company benefits by GH₵9 (GH₵16 – GH₵7) from making units of Product A instead of units of Product B.
  On the basis of this information, the transfer price for Product B should be GH₵64 as long as there is unsatisfied demand for Product A. At this price, there will be no transfers of Product B.