The Rotech group comprises two companies, W Co and C Co.
W Co is a trading company with two divisions: The Design division, which designs wind turbines and supplies the designs to customers under licences and the Gearbox division, which manufactures gearboxes for the car industry.
C Co manufactures components for gearboxes. It sells the components globally and also supplies W Co with components for its Gearbox manufacturing division.
The financial results for the two companies for the year ended 31 May 2014 are as follows:
Required:
(a) Discuss the performance of C Co and each division of W Co, calculating and using the following three performance measures:
(i) Return on capital employed (ROCE)
(ii) Asset turnover
(iii) Operating profit margin
Note: There are 4·5 marks available for calculations and 5·5 marks available for discussion. (10 marks)
(b) C Co is currently working to full capacity. The Rotech group’s policy is that group companies and divisions must always make internal sales first before selling outside the group. Similarly, purchases must be made from within the group wherever possible. However, the group divisions and companies are allowed to negotiate their own transfer prices without interference from Head Office.
C Co has always charged the same price to the Gearbox division as it does to its external customers. However, after being offered a 5% lower price for similar components from an external supplier, the manager of the Gearbox division feels strongly that the transfer price is too high and should be reduced. C Co currently satisfies 60% of the external demand for its components. Its variable costs represent 40% of revenue.
Required: Advise, using suitable calculations, the total transfer price or prices at which the components should be supplied to the Gearbox division from C Co. (10 marks)