Fragrance Pty Ltd has two divisions: the Cologne Division and the Bottle Division. The company is decentralised and each division is evaluated as a profit centre. The Bottle Division produces bottles that can be used by the Cologne Division. The Bottle Division's variable manufacturing cost per unit is $2.00 and shipping costs are $0.10 per unit. The Bottle Division's external sales price is $3.00 per unit. No shipping costs are incurred on sales to the Cologne Division. The Cologne Division can purchase similar bottles in the external market for $2.50.
Assume the Bottle Division has no excess capacity and can sell everything produced externally. Using the general rule, the transfer price from the Bottle Division to the Cologne Division would be:

A) $2.10
B) $2.50
C) $2.90
D) $3.00

The transfer price should be set at the market price for external sales, which is $3.00 per unit. However, the Bottle Division incurs variable manufacturing cost per unit of $2.00 and shipping costs of $0.10 per unit for external sales. Therefore, the minimum acceptable transfer price for the Bottle Division would be $2.10 per unit ($2.00 variable cost + $0.10 shipping cost).

Since the Cologne Division can purchase similar bottles in the external market for $2.50, they would only be willing to purchase from the Bottle Division if the transfer price is lower than that. However, the Bottle Division has no excess capacity and can sell everything produced externally, so they would only be willing to sell to the Cologne Division if the transfer price is higher than their minimum acceptable transfer price of $2.10.

Therefore, the best option is to set the transfer price at the market price for external sales of $3.00 per unit, which is higher than the minimum acceptable transfer price for the Bottle Division and lower than the external market price for the Cologne Division. This results in a transfer price of $2.90 per unit ($3.00 external price - $0.10 shipping cost), which is the correct answer.