A hotel company is divided into two divisions: Construction and Management. The Construction division builds the hotels and the Management division operates the hotels. The Construction division borrows money to cover the cost of construction; the Construction division charges the Management division an annual price per room to use the hotel. The transfer price is used by the Construction division to make the annual debt payments.

The estimated costs of both divisions and the estimated revenues for the Management division for different sizes of hotels are as follows:

a. What room size of the new hotel maximizes the value of the company?

b. If the transfer price is set at $15,000 per year per room, what is the profit of each division?

c. What size of hotel will the Management division choose if the transfer price is $15,000 per year per room?

d. Why is this transfer price not working for the company?

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Room Size Construction Division Annual Debt Costs Management Division Annual Costs Management Division Annual 150 $2,000,000 $10,000,000 Revenues $15,000,000 200 2,400,000 11,000,000 16,500,000 250 2,600,000 12,000,000 18,000,000 300 2,700,000 13,000,000 18,500,000