Problem 1: ROI and Residual Income
Leslie Blandings, division manager of Audiotech Inc., was debating the merits of a new product – a
weather radio that would put out a warning if the county in which the listener lived were under a severe
thunderstorm or tornado alert.
The budgeted income of the division was $725,000 with average operating assets of $3,625,000. The
proposed investment would add income of $640,000 and would require an additional investment in
equipment of $4,000,000. The minimum required return on investment for the company is 12%.
REQUIRED:
1. Calculate the ROI of the division BEFORE the investment and AFTER the investment.
2. Calculate the Residual Income for the division BEFORE the investment and AFTER the
investment.
3. Would Leslie accept the investment opportunity if she is evaluated ONLY based on ROI? If she is
ONLY evaluated based on Residual Income?
Problem #2: Constrained Resource
Billings Company produces three products, Product Reno, Product Vegas and Product Tahoe. Each
product goes through its own assembly and finishing departments. However, all of them must go
through the painting department. The painting department has capacity of 2,460 hours per year.
Product Reno has a unit contribution margin of $120 and requires five hours of painting department
time. Product Vegas has a unit contribution margin of $90 and requires four hours of painting
department time. Product Tahoe has a unit contribution margin of $75 and requires three hours of
painting department time. Demand for each product is 300 units per year.
REQUIRED:
1. Is there a constrained resource?
2. In what order should the products be produced?
3. How many of each product should be produced?
Problem #3: Transfer Pricing
Greenworld, Inc. is a nursery products 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
Greenworld acquired a plastics 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.
The Western Division had bought its plastic pots in lots of 100 from a variety of vendors. The
average price paid was $78 per box of 100 pots. However, the acquisition made Rosario Sanchez-Ruiz ,
manager of the Western Division, wonder whether or not a more favorable 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 an internal transfer. She needs 3,500 boxes. Capacity for the Southern Division is
20,000 and normally sells its pots for $80 per box of 100 pots.
Lorne gathered the following information regarding the cost of a box of 100 pots:




Direct materials
Direct labor
Variable Overhead
Fixed overhead
$35
$18
$10
$10*
* Fixed overhead is based on $200,000/20,000 boxes.
Scenario 1: Southern Division is selling its capacity 20,000 units to outside customers.
Scenario 2: Southern Division is selling 18,000 units to outside customers.
Scenario 3: Southern Division is selling 15,000 units to outside customers.
REQURIED:
For each scenario determine the following:
1. The minimum selling price Southern Division would be willing to accept.
2. The maximum purchase price Western Division would be willing to pay.
3. Is there a negotiable range where an agreement could be reached between Western Division
and Southern Division.
Problem #4: Special Order
Smooth Move Company manufactures professional paperweights and has been approached by a new
customer with an offer to purchase 15,000 units at a per-unit price of $7.00. The new customer is
geographically separated from Smooth Move’s other customers, and existing sales will not be affected.
Smooth Move normally produces 82,000 units but plans to produce and sell only 65,000 in the coming
year. The normal sales price is $12 per unit. Unit cost information is as follows:




Direct materials
Direct labor
Variable overhead
Fixed overhead
$3.00
$2.25
$1.15
$1.80
REQUIRED:
1.
What would be the impact on operating income if the special offer is accepted and what should
Smooth Move do?
2. Assume that the customer wants to have its company logo affixed to each paperweight using a
label. Smooth Move would have to purchase a special logo labeling machine that will cost
$14,000. The machine will be able to label the 15,000 units and then it will be scrapped (with no
further value). No other fixed overhead activities will be incurred. With this additional
information, what would be the impact on operating income if the special offer is accepted and
what should Smooth Move do?
Problem #5: Allocating Service Department Costs
Sharp Motor Company has two operating divisions – an Auto Division and a Truck Division. The
company has a cafeteria that serves the employees of both divisions. The costs of operating the
cafeteria are budgeted at $40,000 per month plus $3 per meal served. The company pays all of the cost
of the meals.
Information regarding meals for June follow:
Auto
Division
Truck
Division
Total
Budgeted Meals
35,000
20,000
55,000
Actual Meals
20,000
20,000
40,000
Peak Period Requirements
28,000
52,000
80,000
Due to layoffs in the Auto Division, the number of actual meals was lower than budgeted. Cost records
in the cafeteria show that actual fixed costs for June totaled $42,000 and that actual meal costs totaled
$128,000.
REQUIRED:
How much cafeteria cost should be allocated to each division for June?
Problem #6: Elimination of a Segment
Operating results last year for Dame Sports Manufacturing Company were disappointing as
shown below:
Footballs
Sales
Basketballs
Baseballs
Total
$300,000
$200,000
$100,000
$600,000
($180,000)
($100,000)
($70,000)
($350,000)
$120,000
$100,000
$30,000
$250,000
Division Fixed Costs
($80,000)
($50,000)
($10,000)
($140,000)
Allocated Corp Fixed Costs
($30,000)
($30,000)
($30,000)
($90,000)
$10,000
$20,000
($10,000)
$20,000
Variable Costs
Contribution Margin
Fixed Costs
Net Income
REQUIRED
In order to improve profits for next year, the president is considering several different options.
Which of the following options would provide the company the highest total profit?
A) Keep all three segments
B) Eliminate the Baseball division and increase sales of Footballs by 20%
C) Eliminate the Baseball division and increase sales of Basketballs by 20%
D) Eliminate the Baseball division and increase sales of Footballs and Basketballs by 10%
Problem #7: Make or Buy
Hendrick Dentistry Services operates in a large metropolitan area. Currently, Hendrick has its own
dental laboratory to produce porcelain crowns. The unit costs to produce the crowns are as follows:




Direct Materials
Direct Labor
Variable Overhead
Fixed Overhead
$70
$27
$ 8
$22 (applied)
Fixed overhead includes the following:
-
Salary of supervisor: $26,000
Rent (lab facility): $32,000
A local dental laboratory has offered to supply Hendrick all the crowns it needs for $125 per crown. If
the offer is accepted the lab facility would be closed. Hendrick estimates that he will need 2,000 crowns
per year.
REQUIRED:
What is the DIFFERENCE in relevant costs between making the crowns and purchasing them? What
should Hendrick do?