Del Norte Paper Company

3 Pages   |   713 Words

The Problem statement

John Powell, general manager - International Operations of Del Norte Paper’s Container Division, is faced with the question of what, if anything should be done about the reluctance of Frank Duffy, his Italian subsidiary manager, to use linerboard manufactured by a Del Norte Paper Company mill in the United States. The Italian subsidiary, the German subsidiary and 20 outside firms have recently submitted bids to an African firm for a contract involving the manufacture of a large quantity of corrugated boxes. DNP-Italia won the contract with a bid of $400 per ton. The winning bid was based on the premise that the linerboard would be purchased in the European “Spot” marketing order to more clearly understand the entities involved in the case look at the Fig 1: Situational Analysis
 

Yes, We Can Help!

We promise to deliver high quality papers on time which will improve your grades. Get help now!

SAMPLES PLACE ORDER OUR SERVICES
Plagiarism Free Work
Best Price Guarantee
100% Money Back Guarantee
Top Quality Work
 
The question to be resolved in the case analysis is what course of action would have been best for the overall corporation. The numerical analyses are shown in the tables 1: Transfer pricing Matrix and Table 2: Make or buy analysis that determines the same result.

Table 1: Transfer pricing Matrix

 
Transfer price range Available capacity
Maximum price (by DNP Italia) $235
Minimum price (by DNP American mill) $251
Net profit/loss (overall company) ($16)
 
  • $235 represents the linerboard cost per ton of corrugated box sold. The actual cost per ton of linerboard used was $220.
  • Thus the relevant ratio is (235/220) = 1.07
  • $251 represents the internal variable costs for DNP American mill ($190*1.07+$45*1.07)
 

Table 2: Make or buy analysis

 
  DNP Italia DNP Deutschland
  Spot KEA Spot KEA
European subsidiary: $400 $400 $400 $400
Sales revenue ($325) ($475) ($310) ($460)
Direct costs        
         
DNP American mill   $134   $134
         
Contribution $75 $59 $90 $74
  • All figures are computed on the basis of one ton of corrugated box output                                                             
  • The sales revenue amount for DNP Deutschland is set at $400, as this was the price in the winning bid                                                       
  • $475= $385+$90; $385 is the KEA price for corrugated box ($360*1.07); $90 is the conversion cost ($325-$235)                                                                  
  • $310=$235+$75; $235 is the price in the spot market; $75 is the conversion cost ($460-$385)                                                         
  • $134=$385 less direct costs ($203, or $190*1,07) and freight cost ($48, or $45*1,07)

Conclusions

As can be seen in these two tables Table 1 & 2, it is unlikely that Frank Duffy’s decision has cost the firm any lost contribution in this particular instance. The “Spot” alternative shows $16 more contribution. The interesting discovery is that the German subsidiary would have contributed the most, by buying “Spot” and selling at the $400 price. This allows the student to raise the question as to why the German subsidiary manager bid is so high. Three possibilities, at least, come to mind here.
  1. First the manager is German and, thus, follows the rules. That is to say, the corporation wants KEA-priced and DNP-produced linerboard used and that’s exactly what he’ll do
  2. A second possible reason is that the German subsidiary, like the Italian one, is viewed and measured as a profit center. Thus, the manager may simply not wish to show a negative profit contribution on each ton shipped. As can be seen below, both subsidiaries would show a loss if they used KEA-priced linerboard, see Table 3: Income Statement.
  3. Finally, is the hypothesis that the German manager full well knows what he’s doing. He may simply not want this business. He is quite possibly either at or near capacity, or believes that he will be at such a position before the order could be filled.  

Table 3: Income Statement

  DNP Italia DNP Deutschland
Sales revenue (per ton) $400 $400
Direct costs, at KEA invoiced prices ($475) ($460)
Contribution ($75) ($60)
 

Recommendations

The possibility exists that Powell’s real concern is that he wanted Duffy to use KEA-priced and DNP-produced linerboard for tax evasion (in Italy) purposes. If the linerboard is invoiced at $385 per ton, as opposed to $235 per ton, $150 per ton of taxable income is, in effect, transferred out of Italy. This is done via the route of having a higher cost-of-goods-sold figure. Thus, while the overall contribution to the corporation may be marginally lower using KEA linerboard, the firm’s after-tax contribution might be higher. This would be true if Italy’s marginal tax rate exceeded that in the United States.  

Download Full Answer

Order Now