Market based and opportunity cost approach - part 1

In this lesson

1. 0:00 Transfer pricing complexities overview
2. 2:15 Spare capacity and opportunity cost concept
3. 4:20 Minimum transfer price calculation method
4. 5:49 Worked example: XY plc component transfer
5. 8:52 Calculating minimum price with marginal cost

About this lesson

This is a crucial skill for Performance Management (PM) and Advanced Performance Management (APM) exams, where transfer pricing decisions directly affect divisional profitability and overall business strategy. We explore the market-based and opportunity cost approach, which forms the foundation of fair transfer pricing in multi-divisional organisations. You'll discover why opportunity cost matters: when a supplying division has no spare capacity, every internal transfer means forgoing an external sale and its associated contribution. The minimum transfer price formula—marginal cost plus opportunity cost—ensures the supplying division remains indifferent between selling internally or externally, preventing divisional managers from making decisions that harm group profitability. Using a worked example with Division X and Division Y, we demonstrate how to apply this approach in practice. You'll see how to identify spare capacity, calculate the opportunity cost of lost external sales, and arrive at the minimum acceptable transfer price by either adding marginal and opportunity costs together or adjusting the external market price for internal cost savings. Both methods yield the same result and help you understand why transfer pricing protects divisional motivation whilst serving the wider business interest.

Duration: 12m