“If I were to price these boxes any lower than $480 a thousand, I’d be countermanding my order of last month for our salesman to stop shaving their bids and to bid full-cost quotations. I’ve been trying for weeks to improve the quality of our business, and if I turn around now and accept this job at $430 or $450 or something less than $480, I’ll be tearing down this program I’ve been working so hard to build up. The division can’t very well show a profit by putting in bids which don’t even cover a fair share of overhead costs, let alone give us a profit.”

Rotch Paper Company is a medium-sized, partly integrated paper company, producing white and kraft papers and paperboard. A portion of its paperboard output was converted into corrugated boxes by the Box Division, which also printed and colored the outside surface of the boxes. Including the Box Division, the company had four producing divisions and a timberland division that supplied part of the company’s pulp requirements.

For several years each division has been judged independently on the basis of its profit. Top management has been working to gain effective results from a policy of decentralizing responsibility and authority for all decisions except those relating to overall company policy. The company’s top management and Board of Directors are convinced that in the past few years the company’s profits and competitive position have definitely improved as a result of decentralization.

The Paper Division (headed by Kent) designed a special display box for one of its papers in conjunction with the Box Division, which was equipped to make the box. Box’s staff for package design and development spent several months perfecting the design, production methods, and materials that were to be used. Because of the box’s unusual color and shape, these were far from standard. According to an agreement between the two divisions, the Box division was reimbursed by the Paper Division for the cost of its design and development work.

When the specifications were all prepared, the Paper Division asked for bids on the corrugated box from the Box Division and from two outside companies. Each division manager normally is free to buy from whatever supplier he wished; and even on sales within the company, divisions are expected to meet the going market price if they want the business. Box has bid a price of $480 per thousand boxes.

Profit margins of converters such as the Box Division are being squeezed. Box Division, as do many other similar converters, buys the paperboard and linerboard used in making boxes, and its function is to print, cut, and shape the material into boxes. Although it bought most of its materials from other Rotch divisions, most of Box’s sales are made to outside customers. If Box gets the order from Paper, it probably will buy its linerboard and corrugating medium from the Paperboard Division of Rotch. The walls of corrugated box consist of outside and inside sheets of linerboard sandwiching the fluted corrugating medium. About 70% of Box’s out-of-pocket (incremental) costs of $400 per thousand boxes represented the cost of linerboard and corrugating medium. Thus, before giving its bid to Paper, Box got a quote for materials from the Paperboard Division. Although the Paperboard Division had been running below capacity and had excess inventory, Dana, its division manager, has quoted the prevailing market price for materials. The Paperboard Division’s out-of-pocket (incremental) costs for both liner and corrugating medium were about 60% of its selling price.

The Paper Division received bids on the boxes of $430 per thousand from West Paper Company, and $432 per thousand from East Paper, Ltd. East Paper offered to buy from Rotch the outside linerboard with the special printing already on it, but it would supply its own inside liner and corrugating medium. The outside liner would be supplied by the Paperboard Division at a price of $90 per thousand boxes, and would be printed for $30 per thousand by the Box Division. Box Division’s out-of-pocket (incremental) costs for the printing would be about $25 per thousand boxes.

Since the biddings results appeared to be a little unusual, Kent, the manager of the Paper Division, discussed the wide discrepancy in the bids with Rotch’s commercial vice president. He told the vice president, “We sell in a very competitive market, where higher costs cannot be passed on. How can we be expected to show a decent profit if we have to buy our supplies at more than 10% over the going market price?”

Knowing that Paul had been unable to operate the Box division at capacity on occasion during the past few months, it seemed odd to the vice president that Paul would add the full 20% overhead and profit charge to its out-of-pocket costs. When he asked Paul about this, the answer he received was the statement that appears at the beginning of the case. Paul went on to say that, having done the developmental work on the box and having received no profit on that work, he felt entitled to a good markup on the production of the box itself.

The vice president explored further the cost structures of the various divisions. He knew that in the absence if specific orders from top management Kent would accept the lowest bid, which was that of the West Paper Company for $430. However, it would be possible for top management to order the acceptance of another bid if the situation warranted such action. And although the volume represented by the transactions in question was less than 5% of the volume of any of the divisions involved, future transactions could conceivably raise similar problems.

Need to use above info to fill in the following diagrams:

Transcribed Image Text:

ROTCH PAPER COMPANY Overview Rotch Paper is a classic case that provides an excellent opportunity to present, analyze, and evaluate transfer pricing issues. In only two pages, the case presents a common business situation involving the relationship between three divisions and suggests several typical transfer pricing solutions. This setting facilitates the discussion of the advantages and disadvantages of each of these solutions as well as topics of coordination among divisions and decision-making policies. It's also an opportunity to consider whether variable costs or full costs are more appropriate for decision-making. Requirements • Fill in the missing prices and costs on the "Diagram of the alternatives" and "Costs of the alternatives" on the following two pages o On the "Diagram of the alternatives", fill in the amounts indicated in the nine dotted ovals. Some amounts may be easy to find in the case, some will need to be computed from case information, and some you will not be able to ascertain from case data; for the latter, write "don't know". Indicate which bid Kent (Paper Division) will accept by highlighting or circling it and labeling it accordingly. o On the "Costs of the alternatives", complete the table using the amounts you entered in the "Diagram of the alternatives" and compute the net costs to Rotch. Indicate which alternative is in the best interest of Rotch Paper as a whole by highlighting or circling it and labeling it accordingly. • The completed "Diagram of the alternatives" and "Costs of the alternatives" with your answers clearly indicated on them are what need to be turned in. • Amounts and answers can be handwritten, and you can just submit the scanned pages of "Diagram of the alternatives" and "Costs of the alternatives". ROTCH PAPER COMPANY Overview Rotch Paper is a classic case that provides an excellent opportunity to present, analyze, and evaluate transfer pricing issues. In only two pages, the case presents a common business situation involving the relationship between three divisions and suggests several typical transfer pricing solutions. This setting facilitates the discussion of the advantages and disadvantages of each of these solutions as well as topics of coordination among divisions and decision-making policies. It's also an opportunity to consider whether variable costs or full costs are more appropriate for decision-making. Requirements • Fill in the missing prices and costs on the "Diagram of the alternatives" and "Costs of the alternatives" on the following two pages o On the "Diagram of the alternatives", fill in the amounts indicated in the nine dotted ovals. Some amounts may be easy to find in the case, some will need to be computed from case information, and some you will not be able to ascertain from case data; for the latter, write "don't know". Indicate which bid Kent (Paper Division) will accept by highlighting or circling it and labeling it accordingly. o On the "Costs of the alternatives", complete the table using the amounts you entered in the "Diagram of the alternatives" and compute the net costs to Rotch. Indicate which alternative is in the best interest of Rotch Paper as a whole by highlighting or circling it and labeling it accordingly. • The completed "Diagram of the alternatives" and "Costs of the alternatives" with your answers clearly indicated on them are what need to be turned in. • Amounts and answers can be handwritten, and you can just submit the scanned pages of "Diagram of the alternatives" and "Costs of the alternatives".

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