Western States Supply – Solution 1. Northwest division management’s attitude at the present time should be positive to each of this prices in decreasing order (obviously preferring a higher to lower price) because Northwest has unused capacity. Northwest division management performance is evaluated based on return on investment (ROI) and each of these prices exceeds variable costs, which will increase Northwest’s ROI. If all existing capacity were being used, however, Northwest division management would want the intracompany transfer price to generate the same amount of profit as outside business in order to maximize division ROI.

2. Negotiation between the two divisions is probably the best method to settle on a transfer price. Western States Supply is organized on a highly decentralized basis and each of the four conditions necessary for negotiated transfer prices exists:
An outside market exists that provides both parties with an alternative.
Both parties have access to market price information.
Both parties are free to buy and sell outside the company.
Top management supports the continuation of the decentralized management concept. 3. The management of Western States Supply probably should not become involved in this controversy. The company is organized on a highly decentralized basis which top management presumably believes will maximize long-term profits. Imposing corporate restrictions could adversely affect the current management evaluation system because division management would no longer have complete control of profits. Also, the addition of corporate restrictions could have a negative motivational impact on division management who are accustomed to an autonomous working environment.

Vac-U-Trac, Inc. – Solution

1. Buffer ROI = $136,500/$975,000 = 14%
Handheld Vacuum ROI = $78,000/$600,000 = 13%

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