please help calculate the transfer pricing for thise case study. I need to do tranfer pricing and then do the quantitative analysis. attached is the case Northwestern Paper come company
oper fiown which are broken down it sept dimoive wwas the lignin (ghur) which bolds them men had been the low-cast upper for many your notion of the timber and popper indus during the early 1990s A recent long-term pulp for example, indicated that Chile was the lows of its US mills at adequate levels. Northwestern had directed le from its U.S. mills whenever possible. The market rate for US. pulp. which. as of late 1993, was in of all production costs and operating expenses, as ven cash constraints in the United States, each sub ing capital needs from local sources. The South Korean subsidiary, which operated a combination pulp and paperboard mill (a "board "in the industry jargon). supplied paperboard to companies located primarily in South Korea and to other countries in the region. The South Korean mill manufactured a portion of the ed to produce the paperboard, and sourced the remainder (predominantly softwood pulp) m's U.S. pulp mills or from other external sources. The Bid Conflict and Northwestern's Transfer Pricing System In early 1994. Suffolk Lid, an Australian manufacturer, submitted a request for bids for a large quantity of bleached paperboard which they intended to use in manufacturing food cartons.' A total of 15 com ies su bmitted bids for the project, including the South Korean subsidiary of Northwestern and another of the company's subsidiaries, which was located in Indonesia. Bids ranged from a low of $640/ ton up to $780/ion. Northwestern's South Korean subsidiary was awarded the contract based on price considerations and quality specifications. In determining the bid price, the South Korean company had calculated the In fact, the domestic industry's expenditures for environmental protection had been over $1 billion annually from 1989 to 1993. Taken from Anderson-Shaw, Carol, "Overcapacity Plagues Paper Producers," Standard & Poors Industry Surveys August 5, 1993. p. B88. Softwood pulp is produced from softwood trees-primarily spruces, firs, hemlocks and pines. Its fibers are longer than those in hardwood trees, resulting in stronger and more durable products. For many paper products, Le., paperboard, softwood and hardwood pulps are mixed together to capitalize on the attributes of both. From Correa, Salvador, "Chile as a World Competitor in Forest Products, " Global Issues and Outlook in Pulp and Paper, (Seattle, Washington: University of Washington Press): 1988. p. 158. Folding carton was used to package food, milk, toiletries and cosmetics, as well as other consumer goods. Paperboard had to meet strict product specifications with regard to folding and printing characteristics. A06-99-0008 46 40cost of the pulp to be used in manufacture of the paperboard at $330/ton. The pulp was to be acquired from a Chilean supplier, rather than from Northwestern's U S. mills. On the other hand. the Indonesian subsidiary had developed their bid submission on the basis of raw pulp priced at the $450/ton rate that It was charged by Northwestern's Everett Washington mill Transfer Pricing at Northwestern Transfer prices between subsidiaries at Northwestern were based on a resale price method in which prices were set at the average sales price charged to unrelated entities With the majority of Northwestern's market pulp production in the United States, this policy had resulted in pulp prices charged to subsid iaries being set at the prevailing U.S. market rate of $450/ton As part of the annual planning process. each of Northwestern's foreign subsidiaries was assigned a certain amount of pulp that it was required to purchase during the year from one of the company's U.S. mills. In evaluating the financial performance of each subsidiary, the Finance Department allocated income generated by the mill in manufacturing and selling the pulp allotment to the subsidiary. The allocation process involved no transfer of funds to the subsidiary; it was merely a book entry made by the corporate office to evaluate the performance of each manufacturing facility or subsidiary The mill income applied to the subsidiaries was calculated by taking the sales price of the ship- ment to the subsidiary less the direct cost and freight charges incurred by the mill. In early 1994, the average Northwestern U.S. mill shipped at a price of $450/ton, and had a direct cost of $280/ton which provided a contribution margin of $170/ton at the U.S. mill.* Freight costs to South Korea and Indonesia were $60/ton and $70/ton, respectively, given shipping distances and routes. In the event that the subsidiary did not order its full allotment of pulp during the year, the resulting down-time expense y taught b at the mill was also allocated to the subsidiary in determining financial performance. Comparison of the Bids Use outside these paramet South Korean Subsidiary. The South Korean subsidiary won the contract for the paperboard shipment with a bid of $655/ton Delivered Duty Paid (DDP) to Suffolk's Australian plant. Although lower bids had been received by Suffolk's purchasing director, this represented the lowest bid from a firm with the reputation of providing the desired level of quality. In the preparation of the bid package, the Chief Financial Officer at the plant in South Korea calculated that the variable cost relative to the project would be approximately $463/ton, which included acquisition of the raw pulp at $330/ton from the use only in the course ACCT 422 at MacEwan University ta Chilean supplier, a 10% wastage charge on the purchased pulp, and $100/ton in other direct conversion costs. Exhibit 1 provides a breakdown of the bid. Indonesian Subsidiary. The bid submitted by the Indonesian subsidiary was for delivery of the paperboard at $780/ton DDP to Suffolk's Australian plant. Variable costs were considerably higher than those of the South Korean bid, totaling $575/ton. This variable cost included a $450/ton cost of pulp purchased from the Everett Mill in the United States, a 10% pulp wastage cost applied to the pulp transfer price, and direct conversion costs of $80/ton." 4 Many of Northwestern's U.S. pulp mills sourced raw wood from the company's wholly owned forest division. Transfer prices were set at market rates. Conversion costs include utilities and other material inputs. Wastage costs are based on the fact that 1 10 tons of market pulp are consumed for every 100 tons of paperboard produced. A06-99-0008 3 47Although not a part of the subsidiary's calculations in determining the bid, in the event that the Indonesian subsidiary had won the contract, its financial performance measurement would have in cluded the allocation of the U.S. mill contribution margin of $170/ton less delivery costs of $70/ton. adjusted for wastage at the Indonesian location. Had the Indonesian subsidiary gone through the Chil can supplier. the pulp could have been acquired for $320/ton DDP Due to differentials in shipping distance, the cost quoted by the Chilean pulp supplier for the Indonesian subsidiary was slightly less than that of the South Korean subsidiary EXHIBIT | Competitive Bids of the South Korean and Indonesian Subsidiaries Subsidiary South Korean Indonesian Delivered Duty Paid $655.00 $780.00 Less variable costs Market pulp (330.00) (450.00) Wastage costs (@10%) (33.00) (45.00) Conversion costs (100 00) (80 00) Gross profit or contribution margin $192.00 $205.00 " All values in U.S. dollars per ton of paperboard. International Directors Meeting As Bill Ewing prepared the agenda for the upcoming International Directors Meeting, he penciled in a presentation by representatives of the Finance Department with respect to the issue of transfer pricing at Northwestern. Among the issues that he believed needed clarification were the following: 1. Given the high degree of competition in bidding for contracts that subsidiaries had encountered, should some alteration be made in the process of calculating bids? 2. What were the advantages and disadvantage of the allocation process used by the corporate office in determining subsidiary performance? Was the process fair to the subsidiaries? Was it fair to the company as a whole? 3 . Given that some of the subsidiaries were located in low-tax jurisdictions, wouldn't it be logical to set transfer prices from the U.S. to those subsidiaries at lower rates? As Ewing thought about the system that was in place, he began to empathize with Kim's position. He knew that the recent economic boom in Asia had created a situation in which Northwestern's sub- sidiaries in that region were growing rapidly (in the 8% per annum range), had high capacity utilization rates, and were operating profitably. Perhaps the company did need to review its approach to transfer pricing. Hopefully, the representatives from the Finance Department would be able to offer some sug- gestions to resolve the apparent problems. . As of early 1994, the federal corporate tax rate in the United States was 34%, with South Korean taxes ranging from 20% to 34%, and Indonesia from 15% to 35%, on a progressive basis. 48W R H M E vers. mal B IN X C + 89UP O THUNDERBIRD Curl A06-99-000B NORTHWESTERN PAPER COMPANY "I understand your motivation for wanting to source the pulp from Chile, but it is important for the corporation to act as an integrated team on these issues. " Bill Ewing, Vice President of International mber 31. 2020 of Northwestern Paper Company, told Arthur Kim. the Director of Northwestern's South Korean sub- sidiary. "Maybe you're right. " Kim responded, "but I just don't understand why it would make sense to pay $450/ton for pulp when I can get it for $330/ton from Chile. It's tough enough to submit competi- tive bids to our customers without that kind of markup on raw materials. Besides, our plant is supposed to be a profit center. Shouldn't we be trying to maximize profits?" "This is a topic that we will be covering in more detail with the finance people at the upcoming International Directors Meeting, " Ewing said. "In the meantime, you need to make sure that you meet your pulp allocation from the Everett (Washington state) mill." s is a copyright violation hit by Jeff Fitzner from Sept Company Background Northwestern Paper Company, a Portland, Oregon-based firm, was founded in 1916. From a single pulp and paper mill at the company's inception, Northwestern had expanded substantially over the years, opening additional pulp and paper mills across the country. By the 1950s, the company was one of the largest U.S. producers of pulp and paper products. During the 1960s and 1970s, the company made a big push toward overseas expansion, particularly into Western Europe, where there was high demand for paper products. As that market had become increasingly competitive, however, expansion focused on Latin America and Asia. By early 1994, the company had mills and/or distribution facilities in 20 countries around the world. It was one of the largest United States-based manufacturers of market pulp, paperboard. and uncoated paper with 1993 sales of approximately $5.5 billion. Market pulp was pulp sold on the open market, rather than being converted into paper at the company's own mills. It was shipped from the mill in bales of dry sheets. Paperboard was used to manufacture folding cartons, milk cartons, disposable cups and plates. Uncoated paper was used in office paper, copier paper, tablets, envelopes, and some printing papers. The early 1990s had proven difficult for Northwestern and other paper companies in the U.S. and Europe. Many of the industry's problems were attributable to the high level of excess production capac- ity. Industry growth during the 1980s led paper companies to invest heavily in new mills and paper machines. Starting in 1990, however, demand for paper products declined. In an attempt to absorb the high fixed costs associated with investments in plant and machinery. several firms in the industry had Copyright @ 1999 Thunderbird. The American Graduate School of International Management. All rights reserved. This case was prepared by M. Edgar Barrett, J. Kenneth and Jeannette Seward Chair in Global Strategy, with the aid of ineffective management. Mitchell W. Shape. Research Assistant, for the purpose of classroom discussion only and not to indicate either effective or 45
