Revision Lecture

Problem 1:

Museum Corporation uses the investment center concept for the museums that it manages. Select
operating data for three of its museums for 2012 are as follows:

St. Louis Dallas Miami

Revenue $1,200,000 $1,500,000 $1,800,000
Operating assets 600,000 500,000 700,000
Net operating income 102,000 112,000 118,000

Required:
a. Compute the return on investment for each division.
b. Which museum manager is doing best based only on ROI? Why?

Answer:
a. St. Louis = $102,000/$600,000 = 0.170
Dallas = $112,000/$500,000 = 0.224
Miami = $118,000/$700,000 = 0.169

b. Dallas was doing the best because the ROI was the highest, and compared to Miami, was
doing better with fewer assets.

Problem 2:
Kase Tractor Company allows its divisions to operate as autonomous units. The operating data
for 20X5 follow:

Plows Tractors Combines

Revenues $2,250,000 $500,000 $4,800,000
Accounts receivable 800,000 152,500 1,435,000
Operating assets 1,000,000 400,000 1,750,000
Net operating income 220,000 60,000 480,000
Taxable income 165,000 90,000 385,000

Required:
a. Compute the investment turnover for each division.
b. Compute the return on sales for each division.
c. Compute the return on investment for each division.
d. Which division manager is doing best? Why?

For parts (b) and (c) income is defined as operating income.

Answer:
a. Investment turnover:
Plows = $2,250,000/$1,000,000 = 2.25
Tractors = $500,000/$400,000 = 1.25
Combines = $4,800,000/$1,750,000 = 2.74

b. Return on Sales:
Plows = $220,000/$2,250,000 = 0.10
Tractors = $60,000/$500,000 = 0.12
Combines = $480,000/$4,800,000 = 0.10

c. ROI:
Plows = 2.25 × 0.10 = 0.225
Tractors = 1.25 × 0.12 = 0.150
Combines = 2.74 × 0.10 = 0.274

d. Combines' manager had the best performance because he had the highest investment
turnover, which offset his second-best return on sales.

Problem 3:

Coptermagic Company supplies helicopters to corporate clients. Coptermagic has two sources of
funds: long term debt with a market and book value of $32 million issued at an interest rate of
10%, and equity capital that has a market value of $18 million (book value of $8 million). The
cost of equity capital for Coptermagic is 15%, and its tax rate is 30%. Coptermagic has profit
centers in four divisions that operate autonomously. The company's results for 2008 are as
follows:

Operating Current
Income Assets Liabilities
New York $1,750,000 $11,500,000 $2,500,000
Chicago 2,400,000 9,000,000 3,500,000
Dalllas 4,675,000 27,500,000 9,500,000
Los Angeles 4,200,000 25,000,000 8,000,000

Required:
a. Compute Coptermagic's weighted average cost of capital.
b. Compute each division's Economic Value Added.
c. Rank the divisions by EVA.

Answer:
a. WACC = [(.10 x (1 - .30) x $32,000,000) + (.15 x $18,000,000)] / $50,000,000
 = 9.88 %

b. New York (EVA) = [($1,750,000 x (1 - .30)] - [0.0988 x ($11,500,000 - $2,500,000)]

= $1,225,000 - $889,200 = $335,800

Chicago (EVA) = [($2,400,000 x (1 - .30)] - [0.0988 x ($9,000,000 - $3,500,000)]

= $1,680,000 - $543,400 = $1,136,600

Dallas (EVA) = [($4,675,000 x (1 - .30)] - [0.0988 x ($27,500,000 - $9,500,000)]

= $3,272,500 - $1,788,400 = $1,494,100

Los Angeles (EVA) = [($4,2000,000 x (1 - .30)] - [0.0988 x ($25,000,000 - $8,000,000)]

= $2,940,00 - $1,679,600 = $1,260,400

c. Rank:
Dallas # 1
Los Angeles # 2
Chicago # 3
New York #4
Problem 4:
X Factor Sports received a special order for 1,000 units of its extreme snowboards at a selling
price of $60 per snowboard. X Factor Sports has enough extra capacity to accept the order. No
additional selling costs will be incurred.

Unit costs to make and sell this product are as follows: direct materials, $34; direct labour, $8;
variable manufacturing overhead, $14; fixed manufacturing overhead, $10.

A) List the relevant costs.

B) What will be the change in operating income if X Factor Sports accepts the special order?
C) Should X Factor Sports accept the special order?
Answer: A)
Relevant costs:
Direct material $34.00
Direct labour $8.00
Variable manufacturing overhead $14.00
Total relevant costs $56.00

B)
Special offer volume 1,000
Special offer price $60.00
Additional revenue from order $60,000

Relevant costs:
Direct material $34.00
Direct labour $8.00
Variable manufacturing overhead $14.00
Total relevant costs $56.00
Special offer volume 1,000
Additional expenses from order $56,000

Additional revenue from order $60,000

Additional expenses from order $(56,000)
Change in operating income $4,000

C) Yes, X Factor Sports should accept the order.

Problem 5:
Victoria Technologies makes a part used in the manufacture of digital cameras. Management is
considering whether to continue manufacturing the part, or to buy the part from an outside source
at a cost of $24.00 per part. Victoria Technologies needs 60,000 parts per year. The cost of
manufacturing 60,000 parts is computed as follows:

Direct materials $750,000

Direct labour 600,000
Variable manufacturing overhead 525,000
Fixed manufacturing overhead 750,000
Total manufacturing costs $2,525,000

If Victoria Technologies buys the part, it would pay $.60 per unit to transport the parts to its
manufacturing plant. Purchasing the part from an outside source would enable the company to
avoid 50% of fixed manufacturing overhead costs. Victoria Technologies' factory space freed up
by purchasing the part from an outside supplier could be used to manufacture another product
with a contribution margin of $70,000.

Prepare an analysis to show which alternative makes the best use of Victoria Technologies'
factory space:
1) Make the part
2) Buy the part and leave facilities idle
3) Buy the part and use facilities to make another product

Answer:

#3: Victoria Technologies should buy the part and use facilities to make another product since
their total costs will be $1,781,000 under this option versus total costs of $2,625,000 to make the
part.

Problem 6:
Rose Incorporated manufactures two types of vases, small and large. The following per unit data
are available:

Small Vase Large Vase

Sale price $60 $100
Variable costs $35 $60
Machine hours required for 1 vase 1 2

Total fixed costs are $600,000 and Rose Incorporated can sell a maximum of 25,000 units of
each type of vase annually. Machine hour capacity is 50,000 hours per year.

Required:
A. Determine the contribution margin per unit for each type of vase.
B. Determine the contribution margin per machine hour for each type of vase.
C. Determine the number of units of each style of vase that Rose Incorporated should produce to
maximize operating income.
D. Compute the dollar amount of the maximum operating income (as calculated in C above).
Answer:
Problem 7:
Electronic Media manufactures DVDs and Blu-ray products. The company's product line income
statement follows:

Blu-ray DVDs Total

Sales revenue $350,000 $112,000 $462,000
Cost of goods sold
Variable $75,000 $49,000 $124,000
Fixed $82,000 $28,000 $110,000
Total cost of goods sold $157,000 $77,000 $234,000
Gross profit $193,000 $35,000 $228,000
Marketing and administrative expenses
Variable $25,000 $28,000 $53,000
Fixed $32,000 $19,000 $51,000
Total marketing and administrative expenses $57,000 $47,000 $104,000
Operating income (loss) $136,000 $(12,000) $124,000

Management is considering dropping the DVD product line. Accountants for the company
estimate that dropping the DVD line will decrease fixed cost of goods sold by $8,000 and fixed
marketing and administrative expenses by $2,000.

Prepare an analysis supporting your opinion about whether or not the DVD product line should
be dropped.
Answer: Contribution margin income statement for DVDs:

If DVDs dropped:
Sales revenue from Blu-ray $350,000
Variable cost of goods sold from Blu-ray $(75,000)
Variable marketing and administrative expenses from Blu-
ray $(25,000)
Contribution margin from Blu-ray only $250,000

Total fixed costs of goods sold $110,000

Decrease in fixed costs of goods sold if DVDs dropped $(8,000)
Fixed costs of goods sold if DVDs dropped $102,000

Total fixed marketing and administrative expenses $51,000

Decrease in fixed marketing and administrative if DVDs
dropped $(2,000)
Fixed marketing and administrative expenses if DVDs
dropped $49,000

Contribution margin from Blu-ray only $250,000

Fixed costs of goods sold if DVDs dropped $(102,000)
Fixed marketing and administrative expenses if DVDs
dropped $(49,000)
Operating income (loss) $99,000

Operating income (loss) from Blu-ray only $99,000

Operating income (loss) with both products $124,000
Decrease in operating income if DVDs dropped $25,000

The company should keep producing and selling DVDs since operating income will decrease by
$25,000 if the product line is dropped.

Problem 8:
Mahtomedi Corporation is considering investing in specialized equipment costing $240,000. The
equipment has a useful life of 5 years and a residual value of $20,000. Depreciation is calculated
using the straight-line method. The expected net cash inflows from the investment are:

Year 1 $60,000
Year 2 $90,000
Year 3 $110,000
Year 4 $40,000
Year 5 $25,000
Total cash inflows $325,000

Mahtomedi Corporation's required rate of return on investments is 14%.

What is the accounting rate of return on the investment?

(Annual net cash flow - depreciation)/Investment = Accounting rate of return
($325,000/5 - (240,000 - 20,000)/5)/240,000
($65,000 - 44,000)/240,000 = 8.75%

Problem 9:
After conducting a market research study, Ed Manufacturing decided to produce a new interior
door to complement its exterior door line. It is estimated that the new interior door can be sold at
a target price of $120. The annual target sales volume for interior doors is 20,000. Ed has target
operating income of 20% of sales.

1) What are target sales revenues?

A) $1,920,000
B) $4,000,000
C) $2,400,000
D) None of these answers is correct.
Answer: C
2) What is the target operating income?
A) $480,000
B) $600,000
C) $384,000
D) $360,000
Answer: A

3) What is the target cost?

A) $1,800,000
B) $1,920,000
C) $2,520,000
D) $2,016,000
Answer: B
Explanation: B) $2,400,000 - ($2,400,000 × 20%) = $1,920,000

4) What is the target cost for each interior door?

A) $96
B) $116
C) $120
D) $90
Answer: A
Explanation: A) [$2,400,000 - ($2,400,000 × 20%)] / 20,000 = $96
Problem 10:
Littrell Company produces chairs and has determined the following direct cost categories and
budgeted amounts:

Standard Inputs Standard Cost

Category for 1 output per input
Direct Materials 1.00 $7.50
Direct Labor 0.30 9.00
Direct Marketing 0.50 3.00

Actual performance for the company is shown below:

Actual output: (in units) 4,000

Direct Materials:
Materials costs $30,225
Input purchased and used 3,900
Actual price per input $7.75
Direct Manufacturing Labor:
Labor costs $11,470
Labor-hours of input 1,240
Actual price per hour $9.25
Direct Marketing Labor:
Labor costs $5,880
Labor-hours of input 2,100
Actual price per hour $2.80

Required:
a. What is the combined total of the flexible-budget variances?
b. What is the price variance of the direct materials?
c. What is the price variance of the direct manufacturing labor and the direct marketing
labor, respectively?
d. What is the efficiency variance for direct materials?
e. What are the efficiency variances for direct manufacturing labor and direct marketing
labor, respectively?

Answer:
a. Actual Results Flexible Budget Variances
Direct materials $30,225 $30,000 $225U
Direct manufacturing labor 11,470 10,800 670 U
Direct marketing labor 5,880 6,000 120 F
$47,575 $46,800 $775 U

b. ($7.75 – $7.50) x (3,900) = $975 unfavorable

c. Manufacturing Labor ($9.25 – $9.00) x 1,240 = $310 unfavorable

Marketing Labor ($2.80 – $3.00) x 2,100 = $420 favorable

d. [3,900 – (4,000 units x 1.00)] x $7.50 = $750 favorable

e. Manufacturing Labor = [1,240 hours – (4,000 x 0.30 hours)] x $9.00 = $360

unfavorable
Marketing Labor = [2,100 hours – (4,000 x 0.50 hours)] x $3.00 = $300.00
unfavorable