Question 1

**Section C**

**Scenario: EcoPower Utilities**

EcoPower is a renewable energy company with two autonomous investment centers: the Generation Division (produces electricity via wind farms) and the Retail Division (sells electricity to residential customers).

Financial data for the Generation Division for the year just ended:
- Operating Profit: $12,500,000
- Total Assets: $85,000,000
- Current Liabilities: $15,000,000
- EcoPower's Cost of Capital: 10%

The Generation Division currently sells 20% of its electricity to the Retail Division and 80% to the national grid (external market). The external market price is $50 per Megawatt hour (MWh). The variable cost of generation is $20 per MWh.

Currently, the transfer price between Generation and Retail is set at the external market price of $50 per MWh.

The Retail Division manager is unhappy. They argue that because Generation incurs no marketing or grid-connection costs on internal transfers (saving $5 per MWh), the transfer price should be lower. The Retail Division has found an external supplier willing to provide electricity at $46 per MWh.

The Generation Division is currently operating at 100% capacity and can sell all the electricity it produces to the national grid at $50 per MWh.

**Required:**

(a) Calculate the Return on Investment (ROI) and the Residual Income (RI) for the Generation Division for the year just ended. (Assume Capital Employed = Total Assets - Current Liabilities). (6 marks)

(b) Based on the general rules of transfer pricing, calculate the minimum transfer price the Generation Division should accept, and the maximum transfer price the Retail Division should pay. (6 marks)

(c) Discuss whether the current transfer price of $50 per MWh is optimal for the EcoPower group as a whole, and recommend a course of action to resolve the dispute between the two divisional managers. (8 marks)

Accepted Answer

Part (a): Use standard formulas. Capital Employed = Total Assets - Current Liabilities. Part (b): Min TP = Marginal Cost + Opportunity Cost. Remember to deduct the $5 savings from the marginal cost. Max TP = External market price available to the buyer. Part (c): Compare the Min and Max TP. Is there a negotiating range? Analyze what happens to the group if Retail buys externally vs internally.

Question 2

What mistakes do candidates make on this ACCA question?

Accepted Answer

Part (a): Using Total Assets instead of Capital Employed. Part (b): Stating Min TP is $50 (forgetting the $5 savings) or $20 (forgetting opportunity cost). Part (c): Failing to recognize that a negotiating range exists between $45 and $46.

How to approach this question

Full Answer

Common mistakes

Practice the full ACCA PM — Performance Management Practice Exam 4

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