Final answer:
When a division operates at full capacity, the transfer price should be based on opportunity cost (A) to account for the foregone revenue from not being able to sell the product externally.
Step-by-step explanation:
When a division is operating at full capacity, the appropriate transfer pricing method should consider the opportunity cost, because the division could potentially sell its products externally instead of internally. Hence, the correct answer is A) based on opportunity cost. This reflects the foregone revenue from not selling the product in the open market.
At this point, setting the transfer price equal to the marginal cost may not be adequate, because it ignores the potential profits that could be earned on external sales. It's important to note that transfer pricing can be complex, and it's essential to consider both internal and external factors when setting these prices.
The reference to opportunity cost implies that another potential option for the product exists, which in a division operating at capacity, would likely be selling the product externally. This approach helps ensure that the company makes the best use of its resources.