Mark’s division has been judged on the basis of its profit and return on investment. Top management has been working to gain effective results from a policy of decentralizing responsibility for all decisions except those relating to overall company policy. Top management feels that the concept of decentralization has been success fully applied and that the company’s profits and competitive position have definitely improved in the last two years.
Mark is considering two alternative bids to submit for a very large project that will rep resent 50% of his division’s activity. He plans to apply the usual 10% profit markup on full costs to both bids.
◆ Alternative 1: Price of $55 per piece (will yield a ROI of 20% and the probability of winning the bid is 80%) About 60% of Mark’s cost represents the cost of parts manufactured by another divi sion of the same company that has been running below capacity and has excess inventory but has quoted the market price. The costs of the supplying division are about 50 percent of the selling price quoted to Mark.
◆ Alternative 2: Price of $52.80 per piece (will yield a ROI of 18% and the probability of winning the bid is 90%) A reduction in prices can be obtained if part of the job is outsourced. The parts that Mark’s division needs can be bought at $28 from an external supplier.
Mark knows that they sell in a very competitive market, where higher costs cannot be passed on. His preference for alternative 2 is opposite to company’s guidelines of buy ing internally, so he asks the CEO, “How can we be expected to show a decent profit and return on investment if we have to buy our supplies internally at more than the market price?” Knowing that the supplying division has on occasion in the past few months been unable to operate at capacity, Mark asserts that it is odd to add the full overhead and profit charge to his costs. In particular, the portion that belongs to corporate overhead that is allocated to all divisions at a rate of 10% of total own costs.
1. Calculate the profit per piece in dollars for Mark’s division under each alternative.
2. Calculate the transfer price at which the parts are being transferred from the internal supplier to Mark’s division. Explain if it is the most adequate in this situation.
3. Explain which alternative is best for Mark.
4. Explain which alternative is best for the whole corporation.