1. Calculating all three options based on costs Thompson Division Costs Linerboard and corrugating medium 168(70%*400)*60% 30% of out of pocket costs 120(30%*400) Total 288 West Papers Costs Total 430 Eire Papers Costs Outside linear(Southern div) 54(60%*90) Printing(Thompson div) 25 Own Supplies 312(432-5-36) Total 391 As shown in the calculations above, Northern should accept the bid from Thompson division as it has the lowest cost if all transfer prices within the company were calculated at
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Also, the transfer price of $480 is higher than the market price which is around $430. Deciding based on transfer price will not induce goal congruence as the situation is not ideal. Without any intervention from the vice president of Birch Paper Company, the Northern division would most probably accept the lowest bid from West Paper Company. This might result in the highest profits for Northern division but it is not in the best interests of Birch Paper Company. Accepting the bid from Thompson division would boost demand for the two other divisions. The losses cut would most probably be more than the costs saved by Northern division which is $50 ($480-$430). The vice president should give specific orders to Northern division to accept the bid from Thompson division. However, as the transaction in this case represents less than 5% of the volume of any of the divisions involved, it might not be possible for the vice president to intervene other transactions when similar problems arise.
The policy can be put regarding the transfer pricing which would be based on the opportunity cost of the divisions. If the divisions is operating at full capacity then the opportunity cost would be the market price that the division is charging for its products and if the division is operating at less than the full capacity and order fulfilment can be achieved at less than the capacity