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Answer A:
Transfer prices based on cost are not appropriate measures of divisional
performance for several reasons, including the following:
 The selling division has little incentive to control costs if all costs will be
recovered in the transfer price.
 The company as a whole often makes poor decisions when one division is
covering another's full costs.
Answer B:
The following table shows the results for both the extraction and pet products

divisions of using the market price as the transfer price.

Answer C:
If Sparta Enterprises let its divisions buy and sell in the open market and also
allowed them to negotiate an acceptable transfer price, the result would be as
follows:
 Any price between $24.50 and $26 will result in an overall benefit to the
company.
 The extraction division would prefer to sell its clay to the pet products
division at the same price it receives in the market: $26 per unit. But it
would be willing to sell at $24.50, because it saves $1.50 in selling costs per
unit by selling within the company.
 Similarly, the pet products division would like to continue paying $22 per
unit for the clay, but if it cannot purchase the clay within the company it will
have to pay the full $26 market price. Therefore, it will be willing to pay the $24.50 transfer price it can negotiate with the extraction division.
Answer D:
Using a negotiated transfer price should result in desirable management behavior because it will:
 Encourage the management of the extraction division to control costs.
 Benefit the pet products division by providing the clay at a below-market price.
 Provide a more realistic measure of divisional performance.