(a) With respect to performance assessment of Ramesh Shah for the years 2024-25 and 2025-26, ANALYZE the potential problems of using the total cost…

(a) 6 (a) UFL acquired BCPL to mitigate the risk of disruptions to the supply chain rather than profit making. Hence, it has adopted an internal transfer pricing policy of charging its entire cost of production plus 15% mark up to UFL based on the ammonium nitrate supplied. For the years 2024-25 and 2025-26, Ramesh Shah's performance is assessed based on other technical and non-financial measures and not on the financial performance of this unit. Therefore, for these years, Ramesh Shah is not being held accountable for the cost of production of the ammonium nitrate supplied to the internal units. He does not have any incentive to identify any opportunities for cost efficiencies. In the long run, this would lead to cost inefficiencies that would reduce the company's overall profit margins. It has already been pointed out by Mohan Lal that UFL has absorbed an increase of 23,000 per ton within these two years. This was due to increase in fixed cost of 20,000 in FY 2025-26 plus 15% mark up on it. While UFL accepted this increase in the interest of goal congruence, in the sense that all the internal units must work towards the overall goal of the company and not just towards their individual unit's objectives. At the same time, Ramesh Shah must be held accountable for managing the cost of production at BCPL in an cost effective manner that will boost the overall profit margins of the company. (b) The plant has been working at full capacity during the year 2026-27. Out of the total capacity of 400,000 tons per annum, 240,000 tons are being supplied to UFL and the balance is being sold externally. Therefore, the minimum transfer price that BCPL will demand = Marginal cost per unit + Opportunity cost per unit = 30,000 per ton +130,000 per ton = 160,000 per ton of ammonium nitrate supplied to UFL. Opportunity cost per unit in this case will be the contribution lost that BCPL could have earned from external sales. The contribution from external sales is calculated as below: Contribution table External sales Selling price per ton 1,80,000 Less: Variable costs Variable manufacturing cost per ton 30,000 Variable costs on external sales 20,000 Total Variable costs per ton 50,000 Contribution per ton 1,30,000 Alternate method: The minimum transfer price can be the price an external customer would pay less any cost savings as a result of transferring internally. External market price is 180,000 per ton of ammonium nitrate. Cost savings on account of internal transfer would be additional variable delivery cost of 18,000 per ton ammonium nitrate to external customers. The price also includes - 2,000 per ton as variable advertising expenses. Market price net of any avoidable expenditure due to internal transfer is 160,000 per ton of ammonium nitrate. The maximum price that UFL will be ready to pay will be the external procurement price at which it can procure from third party suppliers, which is 170,000 per ton of ammonium nitrate. Hence, for the year 2026-27, the suggested price range that can be explored in order to promote goal congruence between Ramesh Shah (head BCPL) and Mohan Lal (director of operations UFL) would be a minimum of 160,000 per ton to 170,000 per ton of ammonium nitrate supplied. (c) When ammonium nitrate is diverted from external sales to captive consumption, BCPL will have to be compensated for the lost contribution. Mohan Lal is trying to convince Ramesh Shah of BCPL to accept an internal transfer price of 155,000 per ton of ammonium nitrate supplied. However, the suggested price range as per answer (b) above is 160,000 per ton to 170,000 per ton of ammonium nitrate supplied. The minimum transfer price that BCPL should charge to recover any lost contribution would be - 160,000 per ton. Therefore, BCPL will incur loss of contribution if Ramesh Shah accepts Mohan Lal's offer of 155,000 per ton as the internal transfer price. (d) The estimated profit per annum for FY 2026-27 of BCPL after capacity expansion, working at full capacity, supplying 240,000 tons at 165,000 per ton to UFL and 160,000 tons at 180,000 per ton to external customers respectively. Sr. No. Particulars Details Total ₹ Total ₹ (crores) 1 Internal sales (240,000 tons * 165,000 per ton) 39,600,000,000 3,960 2 External Sales (160,000 tons * 180,000 per ton) 28,800,000,000 2,880 3 = 1 + 2 Total sales 68,400,000,000 6,840 4 Variable expenses (400,000 tons * 30,000 per ton) 12,000,000,000 1,200 5 Extra variable expenses on external sales (160,000 tons * 20,000 per ton) 3,200,000,000 320 Additional delivery expenses (₹ 18,000 per ton and advertising expenses - 2,000 per ton) 6 Fixed cost after capacity expansion (240,000 tons * 100,000 per ton) + (160,000 tons * 70,000 per ton) 35,200,000,000 3,520 7 = 4 + 5 + 6 Total cost 50,400,000,000 5,040 8 = 3 - 7 Net Profit per annum (estimated) 18,000,000,000 1,800 The estimated net profit of BCPL for FY 2026-27 is 1,800 crores.