Cold Springs has four subunits: Filtering, Bottle Production, Bottling, and Distribution. They are run as independent units and can actually buy their inputs or sell their output either to the next  subunit in line in the process or externally, depending on the path that maximizes their profit. The company currently has all four divisions cooperating in selling product to each other at cost plus a reasonable profit. Recently, Bottling has been approached by an outside customer who would like to buy time on the line. This customer would pay the going market price of $0.05 per bottle of water bottled. It would tanker the water into Bottling’s holding tank and would pick up the bottled water at the end of the line. This outside customer would want 250,000 bottles filled. Bottling currently sells its services to Cold Springs for $0.04 a bottle because it is very efficient. It costs the subunit $0.03 per completed bottle, so the subunit currently gets a 33.3% markup on its costs. If Bottling accepts the outside job, it would either need to run the compensating 250,000 units of internal work on overtime, driving the cost up to $0.045 per bottle leading to an internal price of $0.06 per bottle to keep the same profit margin. Bottling could also refuse the internal business and send the internal business out to a competitor. This competitor would charge the internal customer $0.05, the going market rate, so the company would end up paying market to another company.

REQUIRED:

a. What should the bottling subunit do in this case?

b. What impact will this have on company profits?

c. What transfer price should be used for Bottling under the circumstances presented here to keep the unit’s interests aligned with what is best for the company?