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FRM Financial Risk Manager Practice Test

Category - Terms and concepts

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You are a consultant brought in to help Torrance Electronics, a global conglomerate. Among the companies they own are Torrance's Televisions and MegaMonitors. Mega makes the screens for the TVs and both are considered profit centers. Recently, Torrance's profits have fallen as their competitor has been able to outprice them. This could be an issue of:
  1. Synergies.
  2. Economies of scope.
  3. Transfer pricing.
  4. Licensing.
  5. Cost-based accounting.
Explanation
As the scenario presents itself, it's possible that transfer pricing is the problem. If Mega is itself a profit maximizing group, they are charging the TV division too much for the screens. As such, the TV division is forced to price its TVs at a higher price to maximize its profits.

Key Takeaway: What results is called double marginalization. Torrance sells fewer TVs so Mega actually sells less monitors. While they are maximizing on this number, it would be better if they could work out a revenue sharing agreement based on Torrance maximizing profits for both firms. They would get to share a bigger pie.
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