1. The responsibility structure of the Birch Paper Company and all of its divisions is an Investment Centre.

In the case it is stated that for several years, each division had been judged on the basis of its profit and return on investment. This verifies that BPCs structure is an investment centre, since an investment center has a manager who is responsible for the divisions profits as well as its invested capital. However, as stated in class, some organizations use the terms profit centre and investment centre interchangeably, this is evident by the managers of BPCs divisions continually stressing profit as a major concern. As James Brunner, Thompsons division manager stated, The division cant very well show a profit by putting in bids that dont even cover a fair share of overhead costs, let alone give us a profit. By applying the concept of decentralization, each division in the Birchwood Company was given authority to make decisions except for those related to overall company policy. By having this authority to make decisions, each division manager was able to invest in capital that it felt was needed to maximize overall company profit. Each division manager is evaluated on ROI, which shows how much profit was generated from the capital invested.

2. Out-of-pocket costs are the payments (usually cash or obligations to pay cash) made for resources. Out-of-pocket costs can be the same as opportunity costs, but may not be the some because of imperfect markets and changes in the decisionmaking environment between when a resource was acquired and when it is used.

The following is a calculation of the out-of-pocket costs to Birch Paper Company on the proposed bids. BIRCH PAPER COMPANY WEST PAPER CO: Out of pocket Cost to Birch EIRE PAPER, LTD: Less: Southern profit ($90*40%) Thompson profit ($30-$25) Out of pocket cost to Birch THOMPSON Less: Southern profit ($280*40%) Thompson profit ($480-$400) Out of pocket cost to Birch Per 1,000 boxes $430 $432 $36 5 $41 $391 $480 $112 80 $288 $192

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 Companys 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 companys 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 presidents 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 Less: Southern profit ($280*40%) Thompson profit ($430-$400) Out of pocket cost to Birch $430 $112 30 $288 $142

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 for Birch, more than making up for the loss of profit to Thompson. Currently the management for the Thompson division is not following the market for the pricing of its product, it is possible that Thompson is not operating at efficient levels and their bid price reflects these inefficiencies. Birch should implement a system whereby subordinate divisions must adhere to a pricing strategy that reflects current market prices. This strategy would increase internal purchasing and help to align each divisions goals with that of the Companys, intern, leading to better performance for the company as a whole. In the case the vice president remembers a comment made by a controller, costs which were variable for one division could be largely fixed for the company as a whole. This implies that Birch Paper Company is basing its prices on a full cost approach. When companies use a full cost or absorption cost approach to setting transfer prices between departments then it may lead to

dysfunctional decision-making behavior, as we can see in this case. Using a full cost approach has directed the buying division to view non-unit-level costs for the company as unit-level costs for their division, which intern has lead to faulty decision making. Mr. Brunner is adding a 20% overhead and profit charge to his out-ofpocket costs, even though he is not at full capacity and does not have any opportunity costs to count for, which is causing the company to charge more than they should be charging. If this 20% mark up was dropped then the costs could go down, and the Thompson division could offer the price of $430 or even less to the Northern division which would be a net advantage for the company as a whole.