Problem 4-43 Multiple-Product Analysis, Changes is Sales Mix, Sales to Earn Target Opex

Basu Company produces two types of sleds for playing in the snow: basic sled and aero
sled. The projected income for the coming year, segmented by product line, follows:

Basic Sled Aero sled Total

Sales $3,000,000 $2,400,000 $5,400,000

Total Variable Cost $1,000,000 $1,000,000 $2,000,000
Contribution Margin $2,000,000 $1,400,000 $3,400,000
Direct Fixed Cost $778,000 $650,000 $1,428,000
Product Margin $1,222,000 $750,000 $1,972,000
Common Fixed Cost $198,900
Operating Income $1,773,100

The selling prices are $30 for the basic sled and $60 for aero sled

1. Compute the number of units of each product that must be sold for Basu to break even
Number of units sold

Basic sled Aero Sled

Sales $3,000,000 $2,400,000

Price $30 $60
Units $3,000,000/$30 $2,400,000/60
Units 100,000 40,000
Variable cost/unit $1,000,000/100,000 $1,000,000/40,000
Variable cost/unit $10 $25

Calculate BEP for each product

BEP = Total Fixed Cost/ (Price – Variable Cost)

BEP basic sled = $778,000/ ($30-$10) BEP aero sled = $650,000/ ($60-$25)
BEP basic sled = 38,900 units BEP aero sled = 18,572 units
2. Assume that the marketing manager changes the sale mix of the two products so that the ratio is
five basic sled to three aero sled. Repeat Requirement 1.

Sales mix

Basic Sled: Aero sled

5: 3

Product Price Unit VC Unit CM Sales Mix Package CM

Basic $30 $10 $20 5 $100

Aero $60 $25 $35 3 $105
Total $205

BEP package = Total Fixed Cost/Total Package CM

BEP package = ($1,428,000 + $198,900)/$205
BEP package = 7937

BEP for basic sled = 7937 x 5 BEP for aero sled = 7937 x 3
BEP for basic sled = 39,685 units BEP for aero sled = 23,811 units

3. Refer to Original Data. Suppose that Basu can increase The extra advertising would cost an
additional $195,000 and some of the potential purchasers of basic sled would switch to
aerosleds. In total, sales of aerosled would increaseby 12,000 units, and sales of basic sleds
would decrease by 5000 units. Would Basu be btter with this strategy?

Before Advertising Total

Basic Aero

Units sold 100,000 40,000

Per Unit CM $20 $35
Total $2,000,000 $1,400,000
Direct Fixed Cost $778,000 $650,000
Product Margin $1,222,000 $750,000 $1,972,000
Common Fixed Cost $198,900
Operating income (extra by) $1,773,100
 After Advertising Total
Basic Aero

Units sold 95,000 52,000

Per Unit CM $20 $35
Total $1,900,000 $1,820,000
Direct Fixed Cost $778,000 $650,000
Product Margin $1,122,000 $1,170,000 $2,292,000
Common Fixed Cost $198,900
Advertising Cost $195,000
Operating income (extra by) $1,898,100

By increasing the sales of aero sled by 12,000 units and taking into account the additional
advertising cost incurred, the operating income has increased by $125,000. Basu can go
ahead with this strategy.
Problem 4-48 Cost-Volume-Profit, Margin of Safety

Victoria Company produces a single product. Last year’s income statement is as follows:

Required:

1. Compute the break-even point in units and sales dollars calculated using the breakeven
units.
2. What was the margin of safety for Victoria last year in Sales Dollars/
3. Suppose that Victora is considering an investment in new technology that will increase fixed
cost by $250,000 per year but will lower variable cost to 45% of sales. Units sold will remain
unchanged. Prepare a budgeted income statement assuming that Victoria makes this
investment. What is the new break-even point in sales dollar, assuming that the investment
is made?

Cost-Volume-Profit, Margin of Safety

Income statement
Sales(29,000 units) $ 1,218,000.00 $ 42.00
Total Variable Cost(less) $ 812,000.00 $ 28.00
Contribution margin $ 406,000.00
Total fix cost (less) $ 300,000.00
Operating income $ 106,000.00

1) Break Even Point (BEP) unit

Price per unit = Sales Revenue / total units sold = $1,218,000 / 29000 = $ 42.00

Variable cost per unit = total variable cost / total units sold = $ 812,000/29000 = $ 28.00

Break-Even Point (BEP) unit = Total Fixed Cost / (Price - Variable Cost per unit)
= ($ 300,000.00) / ($ 42.00 - $ 28.00)
= 21429

Break Even Point (sales Dollars)

Sales at Break Even Point (dollar) = Break-Even Point (BEP) unit X Sale Price per unit

$
21429 X $ 42.00 = 900,000.00
Or
Contribution Margin Ratio = Contribution Margin / Sales
$ 406,000.00 / $ 1,218,000.00
= 0.33

Break-Even Point (BEP) sales dollar = Total Fix Cost / Contribution Margin Ratio
 $ 3000,000 / 0.33
=

900,000.00
2) Margin Of Safety in sales Dollars = Sales - Breakeven Sales
Margin Of Safety in sales Dollars = 42 (29000) - 42 (21429)

= $ 1,218,000.00 - $ 900,000.00 = $ 318,000.00

3) Budgeted Income Statement

Sales @ 29,000 units = $ 1,218,000.00

New variable cost @ 45% of Sales

(45/100)(1218000) = $ 548,100.00

Contribution Margin = $ 669,900.00

Fix Cost added $250,000
$ 300,000 + $ 250,000 = ($550,000.00)

Operating Income = $ 119,900.00

New Break Even Point in Sales Dollar

New Variable cost per unit = total variable cost / total units sold = $ 548,100/29000
= $ 18.90

Break-Even Point (BEP) unit = Total Fixed Cost / (Price - Variable Cost per unit)
= ($ 550,000.00) / ($ 42.00 - $ 18.90)
= 23810

Sales at Break Even Point (dollar) = Break-Even Point (BEP) unit X Sale Price per unit

$
=
23810 X $ 42.00 = 1,000,000.00

Or
Contribution Margin Ratio = Contribution Margin / Sales

= $ 669,900.00 / $ 1,218,000.00 = 0.55

Break-Even Point (BEP) sales dollar = Total Fix Cost / Contribution Margin Ratio

= $ 550,000.00 / 0.55

= $ 1,000,000.00
Problem 4-52 Break-Even Sales, Operating Leverage, Charge in InCome

Duncan Macduff
Sales $375,000 $375,000
Total variable cost 300,000 150,000
Contributed Margin $75,000 $225,000
Total fixed cost 50,000 200,000
Operating income $25,000 $25,000

Required:

1. Compute the degree of operating leverage for each company

2. Conceptual Connection: Compute the break-even point in dollars for each company. Explain
why the break-even point for Macduff is higher.
3. Conceptual Connection: Suppose that both companies experience a 30% increase in
revenues. Compute the engineering change in profits for each company. Explain why the
percentage increase in Macduff’s profit is so much higher than Duncan.

1) Contribution Margin
Degree of Operating Leverage =
Net Operating Income

Duncan Macduff
$
$ 75,000 225,000
$
$ 25,000 25,000

DOL = 3 9

2) Break-even point in dollar ($)

Profit = CM ratio X Sales - Fixed expenses

CM
Duncan CM Ratio Macduff Ratio

$
Sales $ 375,000 100% 375,000 100%
$
Variable Cost $ 300,000 80% 150,000 40%
$
$ 75,000 20% 225,000 60%

BE ($) = 20% x Sales - $50,000 60% x Sales - $200,000

20% x Sales = $50,000 60% x Sales = $200,000

 $
Sales = $ 50,000 200,000
20% 60%

$
$ 250,000 333,333

Contribution margin for Macduff is higher compared to Duncan

3) Increase 30% revenue - Percentage (%) change in profits

Duncan Macduff

$
Sales $ 487,500 487,500
$
Variable Cost $ 390,000 195,000
$
Contribution Margin $ 97,500 292,500
$
Fixed Cost $ 50,000 200,000
$
New Profit $ 47,500 92,500

$
Previous profit $ 25,000 25,000

% in change 90% 270%

1) Variable cost increase by 30% but in terms of value (dollar) is lower compared to Duncan

2) Contribution margin is higher.

3) Macduff has higher Fixed cost compared to Duncan but Macduff's contribution margin is higher
than Duncan due to lower Variable cost
Problem 13-39 Special-Order Decision

Rianne Company produces a light fixture with the following unit cost:

Direct Materials $2
Direct Labor 1
Variable
Overhead 3
Fixed overhead 2
Unit Cost $8

The production capacity is 300,000 units per year. Because of a depressed housing market, the
company expects to produce only 180,000 fixtures for the coming year. The company also has fixed
selling costs totalling $500,000 per year and variable costs $1 per unit sold. The fixtures normally sell
for $12 each.

At the beginning of the year, a customer from geographic region outside the normally served by the
company offered to buy 100,000 fixtures for each $7 each. The customer also offered to pay all
transportation costs. Since there would be no sales commission involved this order would not have
any variable selling costs.

Required:

Based on quantitative (numerical) analysis, should the company accept the order?

What qualitative factors might impact the decision? Assume that no other orders are expected
beyond the regular business and the special order.

As per 100,000 units @ $12 per unit selling price

Alternative
Alternative 1 2
Reject Differential
Accept Special Special Benefit to
Order Order Accept

Sales revenue 1,200,000.00 - 1,200,000.00

Direct materials (200,000.00) - (200,000.00)

Direct labor (100,000.00) - (100,000.00)

Variable overhead (300,000.00) - (300,000.00)

Increase/(Decrease) in operating
income 600,000.00 - 600,000.00

As per 100,000 units order @ $ 7 per unit selling price

Sales revenue (7*100,000) 700,000.00 - 700,000.00

Direct materials (2*100000) (200,000.00) - (200,000.00)

Direct labor (1*100000) (100,000.00) - (100,000.00)

Variable overhead (3*100000) (300,000.00) - (300,000.00)

Total net benefit 100,000.00 - 100,000.00

As per unit @ $ 12 per unit selling

price

Alternative
Alternative 1 2
Reject Differential
Accept Special Special Benefit to
Order Order Accept

Sales revenue 12.00 - 12.00

Direct materials (2.00) - (2.00)

Direct labor (1.00) - (1.00)

Variable overhead (3.00) - (3.00)

Increase/(Decrease) in operating
income 6.00 - 6.00
As per unit @ $ 7 per unit selling price

Alternative
Alternative 1 2
Reject Differential
Accept Special Special Benefit to
Order Order Accept

Sales revenue 7.00 - 7.00

Direct materials (2.00) - (2.00)

Direct labor (1.00) - (1.00)

Variable overhead (3.00) - (3.00)

Increase/(Decrease) in operating
income 1.00 - 1.00

Fixed overhead and selling costs are irrelevant because this is special order. If the special order rejected,
there will be no impact on income. Therefore, the quantitative analysis is $ 100,000.00 in favor of accepting
the special order.
Problem 13-40 Make or Buy , Qualitative Considerations

Patrick Dentistry Services operates in a large metropolitan area. Currently, Hetrick has its own dental
laboratory to produce porcelain and gold crowns. The unit costs to produce the crowns are as
follows:

Overhead is applied on the basis of direct labor hours. These rates were computed by using 5500
direct labor hours.

A local dental laboratory has offered to supply Hetrick all the crowns it needs. Its price is $125 for
porcelain crowns and $150 for gold crowns; however the offer is conditional on supplying both types
of crowns – it will not supply just one type for the price indicated. If the offer is accepted, the
equipment used by Hetrick’s laboratory would be scrapped (it is old and has no market value), and
the lab facility would be closed. Hetrick uses 2000 porcelain crowns and 600 gold crowns per year.

Porcelain Gold
Raw Materials $70 $130
Direct Labor 27 27
Variable
Overhead 8 8
Fixed Overhead $127 $187

Fixed Overhead is detailed as below

Salary (supervisor) $26,000

Depreciation 5000

Rent (lab facility) 32,000

Required

Should Hetrick continue to make its own crown, or should they be purchased from the external
supplier? What is the dollar effect of pourchasing?

What qualitative factors should Hetrick consider in making this decision.

Suppose that the lab facility is owned rather than rented and that the $ 32,000 is depreciation rather
than rent. What effect does this have on analysis in requirement 1?

Refer to the original data. Assume that the volume of crowns used is 4200 porcelain and 600 gold.
Should Hetrick make or buy the crowns? Explain the outcome.
1) Cost Item
Make Buy

Raw materials 218,000.00 -

Direct
labor 70,200.00 -

Variable overhead 20,800.00 -

Fixed overhead 58,000.00 -

Purchase cost - 340,000.00

367,000.00 340,000.00
Raw materials (70 x 2,000)+(130 x 600).
Direct labor 27 x
2,600.
Variables overhead 8 x 2,600.
Fixed overhead 26,000 + 32,000.
Purchase cost (125 x 2,000)+(150 x 600).

Net savings by purchasing: 367,000 - 340,000 = 27,000.

Hetrick should purchase the crowns rather than make them.

2) Qualitative factors that Hetrick should consider include quality of crowns, reliability and
promptness of producer, and reduction of workforce.

3) It reduces the cost of making the crowns to 335,000, which is less than the cost of buying.

4) Cost Item
Make Buy

Raw materials 372,000.00 -

direct
labor 129,600.00 -

Variable overhead 38,400.00 -

Fixed overhead 63,000.00 -

Purchase cost 615,000.00

603,000.00 615,000.00 12,000.00

Hetrick should produce its own crowns if demand increases to this level because the
fixed overhead is spread over more units.
Raw materials (70 x 4200)+(130 x 600).
Direct labor 27 x (4200 + 600)
Variables overhead 8 x (4200 + 800).
Fixed overhead 26,000 + 32,000 + 5000.
Purchase cost (125 x 4200)+(150 x 600).
Problem 13-41 Sell or Process Further

Zanda Drug Corporation buys three chemical that are processed to produce two-types of analgesics
used as ingredients for popular over-the counter drugs. The purchased chemicals are blended for
two to three hours then heated for 15 minutes. The results of the process are two separate
analgesics, depryl and pencol, which are sent to a drying room until their moisture content is
reduced to 6-8%. For every 1300 pounds of chemical used , 600 pounds of depryl and 600 pounds of
pencol are produced. After drying, depryl and pencol are sold to companies that process them into
their final form. The selling prices are $12 per pund for depryl and 430 per pound for pencol. The
costs to produce 600 pounds of each analgesics are as follows:

Chemicals $8500

Direct Labor 6735

Overhead 9900

The analgesics are packaged in 20-pound bags and shipped. The cost of each bag is $1.30. Shipping
costs $0.10 per pound.

Zanda could process depryl further by grinding it into a fine powder and then molding the power
into tablets. The tablets can be sold directly to retail drug stores as generic brand. If this route were
taken, the revenue received per bottle of tablets would be $4000, with 10 bottles produces by every
pound of depryl. The cost of grinding and tableting total $2.50 per pound of depryl. Bottles cot $0.40
per each. Bottles are shipped in boxes that hold 25 bottles at a shipping cost of $1.60 per box.

Required

1. Should Zanda sell depryl at split off , or should depryl be processed and sold at tablets?
2. If Zanda normally sells 265,000 pounds of depryl , what will be the difference in profits if
depryl is processed further?

1) Renenues = 600 pound x 10 bottles x 4 24,000.00 Process Further

12 x 600 7,200.00 Sell

Bags = 1.30 x (600/20) 39.00 Sell

Shipping
= (10 x 600)/25) x 1.6 384.00 Process Further

0.1 x 600 60.00 Sell

Grinding = 2.5 x 600 1,500.00 Process Further

Bottles = 10 x 600 x 0.4 2,400.00 Process Further

600 Process Sell Difference

 Pound Further

Revenues 24,000.00 7,200.00 16,800.00

Bags - (39.00) 39.00

Shipping (384.00) (60.00) (324.00)

Grinding (1,500.00) - (1,500.00)

Bottles (2,400.00) - (2,400.00)

Total 19,716.00 7,101.00 12,615.00

Zanda should process depryl further.

Question 2
If Zanda normally sells 265000 pounds of depryl per year, what will be the difference in
profits if depryl is processed further?

2) 12,615.00 / 600 = 21.025 additional income per pound

21.025 x 265,000.00 =
5,571,625.00
Problem 13-42 Keep or Drop

AudioMart is a retailer of radios, stereos, and televisions. The store carries two portable sound
system that have radios, tape players, and speakers. System A, of slightly higher quality than System
B, cost $30 more. With rare exceptions, the store also sells a headset when a system is sold. The
headset can be used with either system. Variable-costing income statements for three products
follow:

The owner os the store is concerned about the profit performance of System B and is considering
dripping it. If the product is dropped, sales of System A will increase by 30% and sales of headsets
will drop by 25%. (Note: Rould all answers to the nearest whole number.)

Required:

1. Prepare segmented income statement for the three products using a better format.
2. Prepare segmented income statements for System A and headset assuming the System B is
dropped. Should B be dropped?
3. Suppose a third system, System C, with a similar quality to System B, could be acquired.
Assume with C the sales of A would remain unchanged: However, C would produce only 80%
of the revenues of B, and sales of the headset would drop by 10%. The contribution margin
ratio of C is 50%, and its direct fixed costs would be identical to those of B. Should system B
be dropped and replaced with system C?

1) Segmented Income Statements For Audio Mart

System A System B Headset Total

Sales 45,000.00 32,500.00 8,000.00 85,500.00

Less: Variable Expenses 20,000.00 25,500.00 3,200.00 48,700.00
Contribution
Margin 25,000.00 7,000.00 4,800.00 36,800.00

Less: Fixed Cost 526.00 11,158.00 1,016.00 12,700.00

Segment Margin 24,474.00 (4,158.00) 3,784.00 24,100.00
Less: Common Fixed Cost 18,000.00
Operating Income 6,100.00

CULCULATION :

Fixed Cost
System A : 45000/85500*18000 = 9474 10000 - 9474 = 526

System B : 32500/85500*18000 = 6842 18000 - 6842 = 11158

Headset : 8000/85500* 18000 = 1684 2700 - 1684 = 1016

Problem 13-45 Product Mix Decision, Single Constraint
Sealing Company manufactures three types of DVD storage units. Each of the three types requires
the use of a special machine that has a total operating capacity of 15,000 hours per year.
Information on the three types of storage units is as follows:

Sealing’s marketing director has assessed demand for the three types of storage units and believes
that the firm can sell as many units as it can produce.

Required
1. How many each type of unit should be produced and sold to maximize the company’s
contribution margin? What is the total contribution margin for your selection.
2. Now suppose that Sealing Company believes it can sell no more than 12,000 of the deluxe
model but up to 50,000 each of the basic and standard models at the selling price estimated.
What product mix would you recommend , and that would be the total contribution margin?

Question 1
How many of each type of unit should be produced and sold to maximize the company's
contribution margin? What is the total contribution margin for your selection.

Basic Standard Delu

Selling price (a) 9.00 30.00 35.

Variable cost (b) 6.00 20.00 10.

Contribution margin c= (a-b) 3.00 10.00 25.

Machine hours required (d) 0.10 0.50 0.7

Contribution margin per hour e= (d*c) 30.00 20.00 33.

Ranking 2 3 1

Product Ranking Unit MH ∑MH CM ∑CM

Deluxe 1 20,000 0.75 15,000 25 500,000

Basic 2 150,000 0.10 15,000 3 450,000

Standard 3 30,000 0.5 15,000 10 300,000

(i) The company should sell the Deluxe unit with contribution margin per machine hour of 33.33
(ii) Sealing can produce 20,000 (15000 / 0.75) Deluxe units per year.
(20000 units x 0.25) would yield total contribution margin of
 500,000.00

Question 2
Now suppose that Sealing Company believes that it can sell no more than 12,000 of the deluxe model but
up to 50,000 each of the basic and standard models at the seliing prices estimated. What product mix
would you recommend, and what would be the total contribution margin?

Product Ranking Unit MH CM ∑CM

Deluxe 1 12,000 9,000 25 300,000

Basic 2 50,000 5,000 3 150,000

Standard 3 2,000 1,000 10 20,000

Total 52,000 15,000 470,000

Recommended product mix for Sealing Company:

Basic : 50,000 units
Standard : 2,000 units
Deluxe : 12,000 units

Total Contribution Margin

= (12000 x25) + (50000 x3) + (2000 x 10)
Total Contribution Margin
= 470,000
Problem 9-53 Cash Budgeting

Jordana Krull owns The Eatery in Miami, Florida. The Eatery is an affordable restaurant located near
tourist attractions. Jordana accepts cash and checks. Checks are deposited immediately . The bank
charges $0.50 per check; the amount per check averages $65. Bad checks that Jordana collect make
up 2% of check revenue.

During a typical month, The Eatery has sales of $75,000. About 75% are cash sales. Estimated sales
for the next three months are as follows:

July $60,000

August 75,000

September 80,000

Jordana thinks that it may be time to refuse to accept checks and to start accepting credit cards. She
is negotiating with a credit card processing service that will allow her to accept all major credit cards.
She would start the new policy on July 1. Jordana estimates that with the drop in sales from the no-
checks policy and the increase in sales from the acceptance of credit cards, the net increase in sales
will be 20%. The credit card processing service will charge no setup fee, however the following fees
and conditions apply:

- Monthly gateway and statement fee totalling $19, paid on the first day of the month.
- Discount fee of 2% of the total sale. This is not paid separately instead, the amount that
Jordana receives from each credit sale is reduced by 2%. For example, on a credit card sale
of $150, the processing company would take $3 and remit a net amount of $147 to
Jordana’s account.
- Transaction fee of $0.25 per transaction paid at the time of transaction.
- There will be a two-de;ay between the date of the transaction and the date on which net
amount will be deposited into Jodana’s account. On average, 94% of a month’s netmcredit
card sales will be deposited into her account that month. The remaining 6% will be
deposited the next month.
- If Jordana adds credit cards, she believes that cash sales will average just 5% of total sales,
and the average credit card transaction will be $50.

Required

1. Prepare a schedule of cash receipt for August and September under the current policy
accepting checks

2. Assuming that Jordana decided to accept credit cards,

a. Calculate revised total sales, cash sales, and credit card slaes by month for August
and September
b. Calculate the total estimated credit card transaction for August and September
3. Prepare a schedule cash receipts for August and September that incorporates the changes in
Policy.
 August September
Estimated sales 75,000 80,000
Cash sales (75%) 56,250 60,000
Checks revenue (25%) 18,750 20,000

Total of checks received (in

pieces)
[ Total checks sales / average
amount per checks - $65 ] 288 308

Bank charges [ $0.50

per checks ] 144 154
Bad checks [ 2% of
checks revenue ] 375 400

Actual checks revenue

[Checks revenue - [Bank
charges+Bad checks] ] 18,231 19,446

Total revenue received

[Cash sales + Actual checks

revenue] 74,481 79,446

‘
Problem 12-35

Ready Electronics is facing stiff competition from imported goods. Its operating income margin
has been deciding steadily for the past several years. The company has been forced to lower
prices so that it can maintain its market share. The operating results for the past 3 years are as
follows:

Year 1 Year 2 Year 3

Sales $10,000,000 $9,500,000 $9,000,000
Operating Income 1,200,000 1,045,000 945,000
Average assets 15,000,000 15,000,000 15,000,000

For the coming year, Ready’s president plans to install a JIT purchasing and manufacturing
system. She estimates the inventories will be reduced by 70% during the first year of operations,
producing a 20% reduction in average operating assets of the company, which would remain
unchanged without the JIT system. She also estimates that sales and operating income will be
restored to Year 1 levels because of simultaneous reduction in operating expenses and selling
prices. Lower selling prices will allow Ready to expand its market share. (Note: Round all
numbers to two decimal places.)

Required

1. Compute the ROI, margin, and turnover for Year 1,2, and 3.
2. Suppose that in Year 4 the sales and operating income were achieved as expected, but
inventors remained at the same level as in year 3. Compute the expected ROI, margin and
turnover. Explain why the ROI increased over the Year 3 level.
3. Suppose that the sales and net operating income for Year 4 remained the same as in Year 3
but inventory reductions were achieved as projected. Compute the ROI, margin, and
turnover. Explain why the ROI exceeded the Year 3 level.
4. Assume that all expectations for Year 4 were realized. Compute the expected ROI, margin,
and turnover. Explain why the ROI increased over the year 3 level.
Problem 12-36 Return on Investment for Multiple Investments, Residual Income

The manager of a division that produces add-on products for the automobile industry has just been
presented of opportunity to invest in two independent projects. The first is an air conditioner for the
back seats of van and minivans. The second is a turbocharger. Without the investment, the division
will have average assets for the coming year 0f $38.9 million and expected operating income of
$4.335 million. The outlay required for each investment and the expected operating income are as
follows:

Air Conditioner Turbocharger

Outlay $750,000 $540,000
Operating
income 90,000 $82,080

Required:

1. Compute the ROI for each investment project.

2. Compute the budgeted divisional ROI for each of the following four alternatives:
a. The air conditioner investment is made.
b. The turbocharger investment is made.
c. Both investments are made.
d. Both investments are made.
e. Neither additional investment is made.

Problem 12-37 Return on Investment and Economic Value Added Calculations with Varying
Assumptions
Knitpix Products is a division of Parker Textiles Inc. During the coming year, it expects to earn income
of $310,000 based on sales of $3.45. Without any new investments, the division will have average
operating assets of $3 million. The division is considering a capital investment project – adding
knittin g machines to produce gaiters – that required an additional investment of $600,000 and
increases net income by $57,500 (sales would increase by $575,000). If made, the investment would
increase beginning operating assets by $600,000 and ending operating assets by $400,000. Assume
that the actual cost per capital for the company is 7%. (Answer with four decimal places.)

Required

1. Compute the ROI for the division without the investments

2. Compute the margin and turnover ratios without the investment. Show the product of the
margin and turnover ratios equals the ROI computed in Requirement 1.
3. Compute the ROI for the division with the new investment. Do you think the divisional
manager will approve the investment?
4. Compute the margin and turnover ratios for the division with the new investment. How do
these compare with the old ratios?
5. Compute the EVA of the division with and without the investment. Should the manager
decide to make knitting machine investment?

Problem 12-38 Transfer Pricing

GreenWorld Inc is a nursery product firm. It has three divisions that grow and sell plants: the
Western Division, the Southern Division, and the Canadian Division. Recently, the Southern Division
of GreenWorl d acquired a plastic factory that manufactures green plastic pots. These pots can be
sold both externally and internally. Company policy permits each manager to decide whether to buy
or sell internally. Each divisional manager is evaluated on the basis of ROI and EVA.

The western Division had bought its plastic pots in lots of 100 from variety of vendors. The average
price paid was 75 per box of 100 pots. However, the acquisition made Rosario Sanchez-Ruiz,
manager of the Western Division, wonder whether or not a more favourable price could be
arranged. She decided to approach Lorne Matthews, manager of the Southern Division, to see if he
wanted to offer a better price for internal transfer. She suggested a transfer of 3500 boxes at $70
per box.

Lorne gathered the following information regarding the cost of a box of 100 pots:

Direct Materials $35

Direct Labor $8

Variable overhead $10

Fixed Overhead $10

Total Unit Cost $63

*Fixed overhead is based on $200,000/20,000 boxes.

Selling price $75

Production Capacity 20,000 boxes

What is transfer pricing? : Transfer price represents the price of goods that are sold , or transferred,
between different division .

1. Conceptual Connection
a. Suppose that the plastic factory is producing at capacity and can sell all that it produces
to outside customers. How should Lorne respond to Rosario’s request for a lower they
transfer price?
Since the Southern Division is producing at capacity and can sell all it produces, Lorne
would refuse the offer of $70/box as Transfer Price. This is because Southern Division
can earn more profit by selling in the outside market for $75/box.

2. Conceptual Connection
a. Now assume that the plastic factory is currently selling 16,000 boxes. What are the
minimum and maximum transfer prices? Should Lorne consider the transfer at $70 per
box?

The minimum Transfer Price (Floor) = Total Variable Cosr.

 = $53/box (35+8+10)

The maximum Transfer Price (Ceiling) = The maximun transfer price is the market price.
Price at the outside market = $ 75/box

Lorne should consider the Transfer Pricing at $ 70/box because it is higher amount than
the minimum transfer which is the cost and their current selling is now below capacity
(16 000 boxes). The manufacturing full capacity is at 20 000. Lorne can utilised its
manufaturing capacity for another 3500 at 70 /box.

3. Conceptual connection
a. Suppose that GreenWorld’s policy is that all transfer prices be set at full cost plus 20%.
Would the transfer take place? Why or why not?

Transfer Price with cost Plus 20% = Transfer Price + (Transfer Price + 20%)

=$63+ (63*0.2)

= 63 + 12.60 = 75.60

Direct Materials $35

Direct Labor $8

Variable overhead $10

Fixed Overhead $10

Total Unit Cost $63

The Western Division will not be interested with cost-based transfer pricing because it is
higher than the original offer ($70/box). But it may be the interest of Southern Division
because the amount is higher than market price ($75/box).