White Mountain Inc., owns a number of food service companies. Two divisions are the Coffee Division and the Bakery Shop Division. The Coffee Division purchases and roasts coffee beans for sale to supermarkets and specialty shops. The Bakery Shop Division operates a chain of bakery shops where the variety of cakes and breads are made on the premises. Coffee is an important item for sale along with the cakes and breads and, to date has been purchased from the Coffee Division. Company policy permits each manager the freedom to decide whether or not to buy or sell internally. Each divisional manager is evaluated on the basis of return on investment and residual income. Recently, an outside supplier has offered to sell coffee beans, roasted and ground, to the Bakery Shop Division for $4.00 per pound. Since the current price paid to the Coffee Division is $4.50 per pound, Mike McDonnald, the manager of the Bakery Shop Division, was interested in the offer. However, before making the decision to switch to the outside supplier, he decided to approach Peter Brown, manager of the Coffee Division, to see if he wanted to offer an even better price. If not, then Mike would buy from the outside supplier. Upon receiving the information from Mike about the outside offer, Peter gathered the following information about the coffee: Direct materials $0.90 Direct labor 0.40 Variable overhead 0.70 Fixed overhead *1.50 Total unit cost $3.50 *Fixed overhead is based on $1,500,000/1,000,000 pounds. Selling price per pound $4.50 Production capacity 1,000,000 pounds Internal sales 100,000 pounds Required: Assume that the Coffee Division is currently selling 950,000 pounds. If no units are sold internally, total coffee sales will drop to 850,000 pounds. Suppose that Peter refuses to lower the transfer price from $4.50. What are the minimum and maximum transfer prices for this situation? Compute the effect on firm wide profits and on each division’s profits. What do you think the impact of Peter rejection of this offer to the company’s goal congruence? Explain your answer. Suppose now White Mountain Inc decide that the two divisions should make transaction internally. The transfer price is the maximum price less $1. Compute the effect on the firm’s profits and on each division’s profits. Who has benefited from the outside bid? What do you think the impact of this policy to the company’s goal congruence? Explain your answer

White Mountain Inc., owns a number of food service companies. Two divisions are the Coffee Division and the Bakery Shop Division. The Coffee Division purchases and roasts coffee beans for sale to supermarkets and specialty shops. The Bakery Shop Division operates a chain of bakery shops where the variety of cakes and breads are made on the premises. Coffee is an important item for sale along with the cakes and breads and, to date has been purchased from the Coffee Division. Company policy permits each manager the freedom to decide whether or not to buy or sell internally. Each divisional manager is evaluated on the basis of return on investment and residual income.

Recently, an outside supplier has offered to sell coffee beans, roasted and ground, to the Bakery Shop Division for $4.00 per pound. Since the current price paid to the Coffee Division is $4.50 per pound, Mike McDonnald, the manager of the Bakery Shop Division, was interested in the offer. However, before making the decision to switch to the outside supplier, he decided to approach Peter Brown, manager of the Coffee Division, to see if he wanted to offer an even better price. If not, then Mike would buy from the outside supplier.

Upon receiving the information from Mike about the outside offer, Peter gathered the following information about the coffee:

Direct materials $0.90
Direct labor 0.40
Variable overhead 0.70
Fixed overhead *1.50
Total unit cost $3.50

*Fixed overhead is based on $1,500,000/1,000,000 pounds.

Selling price per pound $4.50
Production capacity 1,000,000 pounds
Internal sales 100,000 pounds

Required:

1. Assume that the Coffee Division is currently selling 950,000 pounds. If no units are sold internally, total coffee sales will drop to 850,000 pounds. Suppose that Peter refuses to lower the transfer price from $4.50. What are the minimum and maximum transfer prices for this situation? Compute the effect on firm wide profits and on each division’s profits. What do you think the impact of Peter rejection of this offer to the company’s goal congruence? Explain your answer.
2. Suppose now White Mountain Inc decide that the two divisions should make transaction internally. The transfer price is the maximum price less $1. Compute the effect on the firm’s profits and on each division’s profits. Who has benefited from the outside bid? What do you think the impact of this policy to the company’s goal congruence? Explain your answer