Farras Wardana 13/342773/EK/19210

Nabilah Amin Sudarto 17/41599/EK/21599

Nabila Qothrunada 17/408350/EK/21248
Steven Alvero Husen 17/415862/EK/21602

Birch Paper Company Ⓡ

1. Which bid should Northern Division accept that is in the best interests of Birch

Paper Company?

TheBirch Paper Company has the goal of minimizing cost and maximizing profit like any
other company would want. If we are looking at this case from a financial perspective we would
recommend that Birch Paper Company accept the bid set by the Thompson Division, since it would
minimize the cost of the Northern Division.

2. Should Mr. Kenton accept this bid? Why or why not?

As the manager of Northern Division Mr. William Kenton should not accept the bid
because:

● Birch Paper Company decentralized responsibility and authority for each division
based on the profit and return on investment. Mr. Kenton should not accept the
bid from Thompson Division and chose either Eire’s or West Paper bids whom
offered a lower price cost on the interest of Northern Division.

● Since Eire bought the materials form the Southern Division meaning that Eire
contributed to Birch Paper Company as a whole. The Southern Division could
increase the optimization of its capacity and reduce it excess inventory by taking
the order from Eire Paper company.

3. Should the vice president of Birch Paper Company take any action?

The vice president of the company should take an action to set and fix the procedure of
transfer pricing in every division. They also have to fix the transfer pricing policy, even though the
amount of total transfer is less than 5% of the volume of each division. Top management could
also intervene in the division in order to take other offers. This step is needed for the sake of
keeping the profitability of the entire company and keeping the objectives of each division in-sync
(goal congruence), as well as eliminating the possibilities of having a conflict of interest between
division and company.

If the vice president did not take any action, the division could go with the decision of
choosing the Eire Paper to provide the order and ultimately cause inefficiency in the company.
 4. In the controversy described, how, if at all, is the transfer price system
dysfunctional? Does this problem call for change, or changes, in the transfer
pricing policy of the overall firm? If so, what specific changes do you suggest?

The transfer pricing is considered dysfunctional as it did not accommodate the issue with
the market price. Hence, the profit-center transfer pricing should be adjusted based on the cost-
based transfer pricing.

Thompson Division:
Selling price to Northern Division = $480
Profit Margin = ($480 - $400) / $400 = 20%
Out-of-pocket costs = $400
Southern’s selling price to Thompson= 70% x $400 = $280
Other overhead costs = $400 - $280 = $120
Southern Division:
Out-of-pocket costs = 60% x $280 = $168
Southern’s profit = $280 - $168 = $120
Profit margin = $112 / $168 = 67%

Southern Division should reduce the percentage of its profit below 67%. Thompson
Division’s profit should not be lower because the overhead costs and the 67% profit margin should
be adjusted to follow the market price of $430 in the end.

Thompson Division - Adjusted to Market Price:

Selling price to Northern Division = $430
Out-of-pocket costs (20% PM) = $430 / 120% = $358.33
Other overhead costs = $120
New Southern Division’s selling price to Thompson Division = $358.33 - $120 = $238.33
Southern Division (New):
Out-of-Pocket costs = $168
New profits = $238.33 - $168 = $70.33
New profit margin = $70.33 / $168 = 42%

From the calculations, there is a decrease in profit margin for Southern Division form 67%
to 42% so that the selling price can be at the market price. We recommend that top management
should develop an arbitration committee to provide the best solution based on profit sharing and
profit mechanism for the company as a whole without affecting the decentralization that has been
well-established. Profit sharing deals with the share of profit in each division so that each division
can operate well, while profit mechanism deals more with efficiency and effectiveness on each
division such as excess inventory, production, and operation capacity.