Birch Paper Company
... WEST PAPER CO: Out of pocket Cost to Birch $430 EIRE PAPER, LTD: $432 Less: Southern profit ($90*40%) $36 Thompson profit ($30-$25) 5 $41 Out of pocket cost to Birch $391 THOMPSON $480 Less: Southern profit ($280*40%) $112 Thompson profit ($480-$400) 80 $192 Out of pocket cost to Birch $288 3. The best bid for Birch Paper Company would be with Thompson, one of its own divisions, since it represents the lowest out of pocket cost to BPC. As well, if the Northern Division chooses the Thompson division then it may avoid other costs that may be incurred from choosing an external bid. 4. The Northern Division received bids of $480 from Thompson, $430 from West Paper Company, and $432 from Eire Papers, Ltd. Since Birch Paper Company’s responsibility structure is an investment centre as stated above in question one, in order to maximize divisional profits Northern would chose the $430 bid from West since it represents the lowest cost, thereby resulting in higher profits. 5. The question of whether or not the vice president of Birch Paper Company should take action in this matter is a dilemma that has no outright solution, for there are pros and cons on each side. If the vice president gets involved in the bidding process they may face the peril of “undermining the autonomy” of the division managers. However, by not taking action they will loose the cost saving associated with in-sourcing to Thompson. Central managers will only want to intervene if the negative financial consequences are significant. It is stated in the case that, “the volume represented by the transaction in question was less than five percent of the volume of any of the divisions involved,” therefore, since it is a relatively small volume the vice president may feel that their involvement is unnecessary. However, as stated “other transactions would conceivably raise similar problems later.” Due to the possible reoccurrence of these problems it is to the company’s benefit that the vice president should get involved, thereby setting precedence for all division to follow, avoiding future problems. 6. The transfer pricing system is dysfunctional since it is possible for each internal division to price their product above the going market price. This ability for individual price setting deters the divisions from making purchases internally, although in the long run the company benefits from choosing, either internally or externally, the option with the lowest cost to the firm. If Thompson was persuaded to alter their sales cost from $480 to $430 this would make them one of the lowest bidders and intern Northern would be willing to accept their offer. This pricing change would allow Northern to go internally without the vice president’s involvement. Shown below are a break-down of the out of pocket cost to Birch and the reduction of the contribution margin to Thompson. THOMPSON $430 Less: Southern profit ($280*40%) $112 Thompson profit ($430-$400) 30 $142 Out of pocket cost to Birch $288 Although the Thompson division would lose some profit ($80-$30=$50), the price reduction still allows for the same out of pocket cost to Birch of $288. If the price was not changed Northern would have stayed with Western Paper Company resulting in an out of pocket cost to Birch of $430. The price change reflects a $142 ($430-$288) cost saving f...