# Accounting for Decision Making Study Set 5

## Quiz 5 :Responsibility Accounting and Transfer Pricing

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Phipps Electronics Phipps manufactures circuit boards in Division Low in a country with a 30 percent income tax rate and transfers them to Division High in a country with a 40 percent income tax. An import duty of 15 percent of the transfer price is paid on all imported products. The import duty is not deductible in computing taxable income. The circuit boards' full cost is $1,000 and variable cost is$700; they are sold by Division High for $1,200. The tax authorities in both countries allow firms to use either variable cost or full cost as the transfer price. Required: Analyze the effect of full-cost and variable-cost transfer pricing methods on Phipps' cash flows. Free Essay Answer: Answer: Transfer Pricing Transfer pricing is a methodology of deciding the price for some transactions which occurred between different divisions of an organization or between different entities which get controlled by the same entity. The price which gets determined under this methodology is not totally based on the cost of the transaction rather it includes some profit elements also but normally it falls below the market price.In the present case P Company manufactures circuit boards and the applicable tax rate on that division L of the company is 30% and after manufacturing the circuit they get transferred to division H and its income tax rate is 40%. Prepare a schedule to compute the taxable income and total taxes under full and variable cost transfer pricing methods using MS Excel, which will be shown as follows: The result of above will be as follows: Under full cost approach, the total cost of division L gets charged from division H as transfer price which eliminates the taxes of L division and put the whole burden of taxation on H which amounts to$230.
Under variable cost approach, the only variable cost of division L get charged from division H as transfer price which results in a refund of taxes of L division for $90 and the burden of taxation on H is$305 but the overall taxes amount to $215 only. Tags Choose question tag ICB, Intl. ICB has four manufacturing divisions, each producing a particular type of cosmetic or beauty aid. These products are then transferred to five marketing divisions, each covering a particular geographic region. Manufacturing and marketing divisions are free to negotiate among themselves the transfer prices for products transferred internally. The manufacturing division that produces all the hair care products wants a particular hair conditioner it developed and produces for Asian markets priced at full cost plus a 5 percent profit markup, which amounts to$105 per case. The South American marketing division believes it can sell this conditioner in South America after redesigning the labels. However, most South American currencies have weakened the dollar, putting further pressure on the prices of U.S.-produced products. The South American marketing division estimates it can make money on the hair conditioner only if it can buy it from manufacturing at $85 per case. Manufacturing claims that it cannot make a profit at$85 per case. Moreover, the other ICB marketing divisions that are paying around $105 per case will likely want to renegotiate the$105 transfer price if South America marketing buys it for $85. You work for the corporate controller of ICB, Intl. She has asked you to write a short, nontechnical memo to her that spells out the key points she should consider in her upcoming meeting with the two division heads regarding transfer pricing. You are not being asked to recommend a particular transfer price, but rather to list the important issues the controller should be aware of for the meeting. Free Essay Answer: Answer: Net Income: The resultant amount after reducing all expenses of the company weather direct or indirect for the period from all revenues is termed as net income.Cost and Expenses: Cost is the amount expended to any particular product or amount related to any particular product. Whereas, expenses means cost incurred in order to earn income. Prepaid Expense and Outstanding Expense are its two types. It is shown on the debit side of profit and loss Account. The points that shall be considered while discussing the topic of transfer pricing and the same are as follows: 1. The concept of transfer pricing is keen towards transferring the profits on one division of the company into another division but this concept affects the entire profit of the company as a whole because the units or goods that are sold during such transfer of profits is ignored. 2. The transfer price which is used for the transfer of goods from one unit to another is manipulated because the profit of transferring division is included in the transfer price hence the division which is buying those units tends to purchase lesser units because of the inflated price.3. The transfer price which is used for transfer shall be computed by taking into consideration the opportunity costs of the products. 4. The costs of producing the products and selling them to another division will increase the costs because these costs include the profit margin of the transferring division and such thing happens due to the ignorance of opportunity costs. 5. In the company, if there is the availability of spare capacity i.e. the company has enough margin left for producing extra units then its normal capacity at the same vary cost then it shall transfer the units to other division at the variable costs. Tags Choose question tag Sunder Properties Brighton Holdings owns private companies and hires professional managers to run its companies. One company in Brighton Holdings' portfolio is Sunder Properties. Sunder owns and operates apartment complexes, and has the following operating statement. Brighton Holdings estimates Sunder Properties' before-tax weighted average cost of capital to be 15 percent. Brighton Holdings rewards managers of their operating companies based on the operating company's before-tax return on assets. (The higher the operating company's before-tax ROA, the more Sunder managers are paid.) Sunder Properties' total assets at the end of the last fiscal year are$64 million. Required: a. Calculate Sunder's ROA last year. b. Sunder management is considering purchasing a new apartment complex called Valley View that has the following operating characteristics (millions $): Will the managers of Sunder Properties purchase Valley View? c. If they had the same information about Valley View as Sunder's management, would the shareholders of Brighton Holdings accept or reject the acquisition of Valley View in part (b)? d. What advice would you offer the management team of Brighton Holdings? Free Essay Answer: Answer: Return on assets (ROA) Return on assets is calculated as percentage of operating income earned on the total invested assets of company. Higher return on assets indicates higher profitability of company while lower return on assets indicates lower profitability. Formula to calculate return on assets a.In the given case profits would be operating profit before taxes and thus interest expense would be added back to the net income before taxes. Calculate S's ROA last year as shown below Thus, S's return on assets last year is b.Calculate revised ROA of S after purchase of new complex as shown below Thus, revised ROA is The ROA after purchase of new complex is above before weighted average cost of capital of 15% however below the last year's ROA of 26.25% and thus managers of S would reject the purchase.c.Calculate ROA of only V's complex as shown below Thus, ROA is 20.05% This, ROA is higher than S's weighted average cost of capital of 15% shareholders would allow the acquisition as it is profitable for them. d.The method used to compensate managers of S is not correct. This is because managers would then see the investment benefit from their point of view rather than from company's view. In part (b) even though the complex purchase is profitable it is rejected due to lower ROA. Management should therefore compensate based on residual income rather than ROa. Tags Choose question tag Wegmans Wegmans, a privately owned regional supermarket chain founded in Rochester, New York, in 1916, focuses on the more affluent market by providing a unique shopping experience and value. Wegmans' much larger stores stock roughly twice as many items as other supermarkets and offer more displays of fresh produce, artisan breads, fresh seafood, and take-out or in-store dining of restaurant-quality entrees. The company currently operates more than 80 stores and 10 regional distribution centers in five states stretching from New York to Virginia. Their most recent expansion is into Virginia with three new stores and a new Wegmans Virginia distribution center serving the three new stores, but with capacity to serve more Virginia stores as they are opened. As Wegmans expands geographically, it must open regional distribution centers that are responsible for accurate and on-time selection, inventorying, and delivery of the thousands of products (fresh produce, meats, seafood, frozen goods, etc.) sold in the stores in that distribution center's region. Each store in the region is allocated a share of the costs of its distribution center based on total store revenues served by the distribution center. Senior management uses residual income to evaluate the performance of each store (and reward store management). All Wegmans stores face the same weighted-average cost of capital (13 percent) applied to direct investment in each store (working capital and property, building, and fixtures). The following table summarizes last year's operations of the newest Virginia store (Virginia 3), Wegmans flagship store (Rochester 1), and the Wegmans store with median revenues across the entire 80-store chain (Median). Virginia 3's results in the table represent the first complete year of operations since opening the store. "Rochester 1" is Wegmans' first megastore, rebuilt and expanded in 1990, with a very large and loyal customer base. All figures are in thousands of dollars. Required: a. Compute the residual incomes for the Virginia 3, Rochester 1, and the Median stores. b. Write a memo to senior Wegmans management evaluating the performance of Virginia 3 relative to Rochester 1 and to the Median store. Be sure to provide credible explanations for all material differences in performance between Virginia 3 and the other two Wegmans stores. Essay Answer: Tags Choose question tag Creative Learning Centers Creative Learning Centers (CLC), a for-profit firm, operates over 100 preschools primarily located in the northeast for children ages 4-6. CLC's innovative curriculum utilizes the latest technology and offers young minds creative expression, language and social skills, physical movement, music, and number skills-all provided by professional trained teachers. CLC leases buildings for their schools and invests substantial resources in leasehold improvements for classrooms, technology, and playground equipment. CLC's cost of capital is 12 percent. Typical tuition is about$6,300 per year for a five-day-a-week, four-hour-per-day program. Maria Schnelling manages 15 CLC schools in the state of Virginia. She has decision-making responsibility for staffing and operating her schools, as well as the responsibility for recommending adding new schools and closing existing schools. The following table provides current operating data on all of her 15 preschools, and breaks out her top- and bottom-performing schools: "After-tax operating income" represents all revenues less all expenses (including depreciation and taxes but excluding any interest on debt to finance the investment) of running a school for the last 12 months. Ms. Schnelling has identified three possible locations for new CLC preschools in Virginia (denoted as NVA1, NVA2, and NVA3).The following table provides current projected data on the three new preschools: Required: a. If Maria Schnelling is evaluated and rewarded based on after-tax operating income, which of her 15 existing schools will she recommend closing, and which of her three new schools will she recommend opening? (Justify your answers.) b. If Maria Schnelling is evaluated and rewarded based on return on investment, which of her existing 15 schools will she recommend closing, and which of her three new schools will she recommend opening? (Show computations.) c. You have been hired as a consultant to the board of directors to advise the board as to how CLC should measure and reward the performance of CLC managers, such as Ms. Schnelling in Virginia. How should CLC measure and reward its state managers? Provide a compelling rationale to support your recommendation. (Support your recommendation with relevant computations.)

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Celtex Celtex is a large and very successful decentralized specialty chemical producer organized into five independent investment centers. Each of the five investment centers is free to buy products either inside or outside the firm and is judged based on residual income. Most of each division's sales are to external customers. Celtex has the general reputation of being one of the top two or three companies in each of its markets. Don Horigan, president of the synthetic chemicals (Synchem) division, and Paul Juris, president of the consumer products division, are embroiled in a dispute. It all began two years ago when Juris asked Horigan to modify a synthetic chemical for a new household cleaner. In return, Synchem would be reimbursed for out-of-pocket costs. After Synchem spent considerable time perfecting the chemical, Juris solicited competitive bids from Horigan and some outside firms and awarded the contract to an outside firm that was the low bidder. This angered Horigan, who expected his bid to receive special consideration because he developed the new chemical at cost and the outside vendors took advantage of his R D. The current conflict involves Synchem's production of chemical Q47, a standard product, for consumer products. Because of an economic slowdown, all synthetic chemical producers have excess capacity. Synchem was asked to bid on supplying Q47 for the consumer products division. Consumer products is moving into a new, experimental product line, and Q47 is one of the key ingredients. While the order is small relative to Synchem's total business, the price of Q47 is very important in determining the profitability of the experimental line. Horigan bid $3.20 per gallon. Meas Chemicals, an outside firm, bid$3.00. Juris is angry because he knows that Horigan's bid contains a substantial amount of fixed overhead and profit. Synchem buys the base raw material, Q4, from the organic chemicals division of Celtex for $1.00 per gallon. The organic chemical division's out-ofpocket costs (i.e., variable costs) are 80 percent of the selling price. Synchem then further processes Q4 into Q47 and incurs additional variable costs of$1.75 per gallon. Synchem's fixed manufacturing overhead adds another $0.30 per gallon. Horigan argues that he has$3.05 of cost in each gallon of Q47. If he turned around and sold the product for anything less than $3.20, he would be undermining his recent attempts to get his salespeople to stop cutting their bids and start quoting full-cost prices. Horigan has been trying to enhance the quality of the business he is getting, and he fears that if he is forced to make Q47 for consumer products, all of his effort the last few months will be for naught. He argues that he already gave away the store once to consumer products and he won't do it again. He asks, "How can senior managers expect me to return a positive residual income if I am forced to put in bids that don't recover full cost?" Juris, in a chance meeting at the airport with Debra Donak, senior vice president of Celtex, described the situation and asked Donak to intervene. Juris believed Horigan was trying to get even after their earlier clash. Juris argued that the success of his new product venture depended on being able to secure a stable, high-quality supply of Q47 at low cost. Required: a. Calculate the incremental cash flows to Celtex if the consumer products division obtains Q47 from Synchem versus Meas Chemicals. b. What advice would you give Debra Donak? Essay Answer: Tags Choose question tag US Copiers US Copiers manufactures a full line of copiers including desktop models. The Small Copier Division (SCD) manufactures desktop copiers and sells them in the United States. A typical model has a retail price of less than$500. An integral part in the copier is the toner cartridge that contains the black powder used to create the image on the paper. The toner cartridge can be used for about 10,000 pages and must then be replaced. The typical owner of an SCD copier purchases four replacement cartridges over the life of the copier. SCD buys the initial toner cartridges provided with the copier from the Toner Division (TD) of US Copiers. TD sells subsequent replacement cartridges to distributors that sell them to U.S. retail stores. Toner cartridges sell to the end consumer for $50. TD sells the cartridges to distributors for about 70 percent of the final retail price paid by the consumer. The Toner Division manager argues that the market price to TD of$35 (70% × $50) is the price SCD should pay to TD for each toner cartridge transferred. Required: a. Why does US Copiers manufacture both copiers and toner cartridges? Why don't separate firms specialize in either copiers or toner cartridges like Intel specializes in making computer chips and Gateway specializes in assembling and selling PCs? b. You work for the president of SCD. Write a memo to your boss identifying the salient issues she should raise in discussing the price SCD should pay TD for toner cartridges included in SCD copiers. Essay Answer: Tags Choose question tag Shop and Save Shop and Save (S S) is a large grocery chain with 350 supermarkets. Twenty-eight S S stores are located within the Detroit metropolitan region and serviced by the S S Detroit Bakery, a large central bakery producing all of the fresh-baked goods (breads, rolls, donuts, cakes, and pies) sold in the 28 individual S S stores in the Detroit region. Besides selling S S baked goods, the stores also sell other nationally branded commercial baked goods both in the baked goods section of the store and in the frozen section as well. But all freshly baked items sold in the 28 S S stores come from the S S Detroit Bakery. Each store orders all the baked goods from the S S Detroit Bakery the day before. The S S Detroit Bakery also is a profit center and sells only to the 28 Detroit S S stores. Each store pays the bakery 60 percent of the retail selling price. So, for example, if a store manager orders from the bakery a loaf of whole grain bread that has a retail price of$5.00, that store is charged $3.00 (60% ×$5.00) and the Detroit Bakery records revenues of $3.00. Each store manager is evaluated and compensated as a profit center and has some decision rights over the particular items stocked in each store. But roughly 85 percent of all SKUs (stock keeping units) carried by each store and the retail price of each SKU are dictated centrally by the S S Detroit Regional headquarters, which oversees both the 28 stores and the bakery. Each store manager has decision rights over the quantity of the various baked goods ordered from the S S Detroit Bakery. The retail price of each freshly baked item produced by the S S Detroit Bakery and sold in the grocery stores is set by the Detroit Regional headquarters, not the individual grocery stores or the S S Detroit Bakery. The manager of the Detroit Bakery complains that the reason her central bakery loses money is that the 60 percent rate is too low to cover her costs. The individual grocery store managers complain that the quality and variety of fresh baked goods they receive from the S S Detroit Bakery are not competitive with high-end private specialty bake shops in the Detroit area. Required: a. Evaluate the advantages and disadvantages of the S S policy of each S S grocery store paying the S S Detroit Bakery 60 percent of the retail price of the bakery item. b. Suggest ways that S S can improve the relationship between its grocery stores and its central bakery. Essay Answer: Tags Choose question tag Performance Technologies Sylvia Zang is president of the Wilson Division of Performance Technologies, a multinational conglomerate. Zang manages$100 million of assets and is currently generating earnings before interest (EBI) of $12 million. The corporate office of Performance Technologies has determined that Wilson's existing assets have a risk-adjusted cost of capital of 11 percent. All division presidents (including Zang) are rewarded based on their individual division's ROA. If Zang is able to increase the Wilson Division's current ROA, she can earn a substantial bonus whereby the larger the increase in the division's ROA, the larger is Zang's bonus. Performance Technology computes ROA as EBI divided by total assets. Currently, Zang is considering two new investment opportunities: Project A and Project B. She can accept one or the other, or both, or neither. Each project, A and B, has a risk profile that differs from that of her existing portfolio of assets. Project A (with a risk-adjusted cost of capital of 15 percent) requires her purchasing new assets for$25 million that will generate EBI of $3.5 million. Project B (with a risk-adjusted cost of capital of 9 percent) requires her purchasing new assets for$30 million that will generate EBI of $3 million. Assume there are no synergies between Wilson's existing assets and either project A and B, and there are no synergies between project A and project B. Required: a. Assuming that Zang is rewarded based on improving the ROA of the Wilson Division, will she accept or reject projects A and B? Support your answer with detailed computations. b. Instead of basing divisional managers' bonuses on ROA, Performance Technologies switches to residual income as the methodology used to measure divisional performance and reward divisional managers, including Ms. Zang. Assuming that Zang is rewarded based on improving the residual income of the Wilson Division, what decision(s) will she make regarding accepting or rejecting projects A and B? Support your answer with detailed computations. c. Discuss why your answers differ or are the same in parts (a) and (b). d. Should Performance Technologies use ROA or residual income to evaluate and reward division managers? Justify your recommendation with sound logical analysis. Essay Answer: Tags Choose question tag Royal Resort and Casino Royal Resort and Casino (RRC), a publicly traded company, caters to affluent customers seeking plush surroundings, high-quality food and entertainment, and all the "glitz" associated with the best resorts and casinos. RRC consists of three divisions: hotel, gaming, and entertainment. The hotel division manages the reservation system and lodging operations. Gaming consists of operations, security, and junkets. Junkets offers complimentary air fare and lodging and entertainment at RRC for customers known to wager large sums. The entertainment division consists of restaurants, lounges, catering, and shows. It books lounge shows and top-name entertainment in the theater. Although many of those people attending the shows and eating in the restaurants stay at RRC, customers staying at other hotels and casinos in the area also frequent RRC's shows, restaurants, and gaming operations. The following table disaggregates RRC's total EVA of$12 million into an EVA for each division: Based on an analysis of similar companies, it is determined that each division has the same weighted-average cost of capital of 15 percent. Across town from RRC is a city block with three separate businesses: Big Horseshoe Slots Casino, Nell's Lounge and Grill, and Sunnyside Motel. These businesses serve a less affluent clientele. Required: a. Why does RRC operate as a single firm, whereas Big Horseshoe Slots, Nell's Lounge and Grill, and Sunnyside Motel operate as three separate firms? b. Describe some of the interdependencies that are likely to exist across RRC's three divisions. c. Describe some of the internal administrative devices, accounting-based measures, and/or organizational structures that senior managers at RRC can use to control the interdependencies that you described in part (b). d. Critically evaluate each of the "solutions" you proposed in part (c).
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Warm Boots Warm Boots manufactures and sells a patented ski boot with 9-volt batteries designed to keep a skier's feet warm even when the outside temperature reaches -10 °Celsius. Warm Boots is organized into three divisions: Administration (accounting, finance, human resources, CEO, and CFO), Manufacturing, and Marketing and Sales. To promote cost efficiency, Manufacturing is treated as a cost center, where its managweek times the actual average cost of manufacturing the boots in that week. The manager of M S has the discretion to set the price per pair of boots and is paid a bonus based on M S reported profits. The following table summarizes how price and total cost varies with the number of boots produced and sold PER WEEK. "Total Cost" includes both fixed and variable cost where the fixed cost is the annual fixed cost divided by 52 (the number of weeks in the year). Required: a. As the head of Manufacturing, how many boots will you manufacture if given the discretion to set production levels? Show calculations to support your answer. b. If you managed the M S Division of Warm Boots, and given the production level (and its resulting average cost) chosen by the Manufacturing manager in part a, what price (and quantity level) would you choose for a pair of boots that maximizes your bonus? Show calculations to support your answer. c. Given the decisions of the Manufacturing and M S managers in parts (a) and (b), is the firm maximizing profits? Explain why profits are or are not being maximized.
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Zee Spin Wedges Zee Spin manufactures a line of golf club wedges (sand wedge, pitching wedge, lob wedge, and attack wedge) that vary with loft and club head sole design. The wedges have become very popular among professional and serious golfers because of their unique club head design and shafts. All Zee Spin wedges consist of three parts: club head, shaft, and grip. Zee Spin manufactures the club heads and shafts and purchases the grips. The three components are assembled to produce a wedge that is sold to distributors, who then sell them to golf pro shops and websites. The shafts are specially designed to match the playing characteristics of the Zee Spin wedge club head. The following table summarizes the total costs of producing a complete Zee Spin wedge. All the various models of Zee Spin wedges (sand wedge, pitching wedge, lob wedge, and attack wedge) have the same cost structure. Zee Spin traditionally only sold complete wedges (club head, shaft, and grip), and the company Was treated as a single profit center. But with the success of the Zee Spin brand and recent inquiries from other club makers about purchasing just Zee Spin shafts, which are unique in the industry, Zee Spin is going to sell both complete wedges (as they do now) and individual shafts. To implement this strategy, Zee Spin will create two profit centers: Wedges and Shafts. The Shaft profit center will produce shafts for external customers, as well as for the Zee Spin Wedge profit center. There will be two profit center managers in Zee Spin that will be rewarded based on the profits of their respective profit centers. The Zee Spin wedges will continue to be sold for $75 per complete wedge, while the shafts will be sold for$23 per shaft. Shafts that are sold externally will incur variable selling costs of $2.43 (primarily sales commission and shipping). These costs are not incurred for shafts sold internally to the Wedge profit center. Required: a. The owners of Zee Spin want to maximize profits and realize that, to properly motivate the managers of the Wedges and Shafts profit centers, they need to set the proper transfer price for the shafts produced by the Shafts profit center and sold to the Wedges profit center. Using the actual data provided in the problem, what transfer price should be used for the shafts produced by the Shafts profit center and sold to the Wedges profit center? (Your answer should be a specific number, such as$18.00.) b. After implementing the transfer price policy you described in part (a), what problems should the owners of Zee Spin anticipate? Stated differently, what non-firm-value maximizing behaviors by the two profit center managers should the owners of Zee Spin expect to occur?
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Cogen Cogen Cogen's Turbine Division manufactures gas-powered turbines for generating electric power and hot water for heating systems. Turbine's variable cost per unit is $150,000 and its fixed cost is$1.8 million per month. It has excess capacity. Cogen's Generator Division buys gas turbines from Cogen's Turbine Division and incorporates them into electric steam-generating units. Both divisional managers are evaluated and rewarded as profit centers. The Generator Division has variable cost of $200,000 per completed unit, excluding the cost of the turbine, and fixed cost of$1.4 million per month. The Generator Division faces the following monthly demand schedule for its complete generating unit (turbine and generator): Required: a. If the transfer price of turbines is set at Turbine's variable cost ($150,000), how many turbines will the Generator Division purchase to maximize its profits? b. The Turbine Division expects to sell a total of 20 turbines a month, which includes both external and c. If the transfer price of turbines is set at Turbine's (average) full cost calculated in part (b), how many turbines will the Generator Division purchase? d. Should Cogen use a variable-cost transfer price or a full-cost transfer price to transfer turbines between the Turbine and Generator divisions? Why? Essay Answer: Tags Choose question tag Economic Earnings A large consulting firm is looking to expand the services currently offered its clients. The firm has developed a new performance metric called "Economic Earnings," or EE for short. The performance metric is argued to be a better measure of both divisional performance and firmwide performance, and hence "a more rational platform for compensating employees and managers." The consulting firm is seeking to convince clients they should replace their current metrics, such as accounting net income, ROA, EVA, and so forth, with EE. EE starts with traditional accounting net income but then makes a series of adjustments. The primary adjustment is to add back depreciation and then subtract a required return on invested capital. The consultants argue for adding accounting depreciation back because it is a sunk cost. It does not represent a current cash flow. For example, suppose a client has accounting net income calculated as: Suppose the client has total assets of$6,000 and a risk-adjusted weighted-average cost of capital (WACC) of 25 percent. Then this client's EE is calculated as follows: Required: Critically evaluate EE as a performance measure. What are its strengths and weaknesses?
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Canadian Subsidiary The following data summarize the operating performance of your company's wholly owned Canadian subsidiary for 2009 to 2011. The cost of capital for this subsidiary is 10 percent. Required: Critically evaluate the performance of this subsidiary.
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Microelectronics Microelectronics is a large electronics firm with multiple divisions. The circuit board division manufactures circuit boards, which it sells externally and internally. The phone division assembles cellular phones and sells them to external customers. Both divisions are evaluated as profit centers. The firm has the policy of transferring all internal products at market prices. The selling price of cellular phones is $400, and the external market price for the cellular phone circuit board is$200. The outlay cost for the phone division to complete a phone (not including the cost of the circuit board) is $250. The variable cost of the circuit board is$130. Required: a. Will the phone division purchase the circuit boards from the circuit board division? (Show calculations.) b. Suppose the circuit board division is currently manufacturing and selling externally 10,000 circuit boards per month and has the capacity to manufacture 15,000 boards. From the standpoint of Microelectronics, should 3,000 additional boards be manufactured and transferred internally? c. Discuss what transfer price should be set for part (b). d. List the three most important assumptions underlying your analysis in parts (b) and (c).
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Beckett Automotive Group Beckett is a large car dealership that sells several automobile manufacturers' new cars ( Toyota, Ford, Lexus, and Subaru). Beckett also consists of a Pre-owned Cars Department and a large service department. Beckett is organized into three profit centers: New Cars, Pre-owned Cars, and Service. Each profit center has a manager who is paid a fixed salary plus a bonus based on the net income generated in his or her profit center. When customers buy new cars, they first negotiate a price with a new car salesperson. Once they have agreed on a price for the new car, if the customer has a used car to trade in, the Pre-owned Cars Department manager gives the customer a price for the trade in. If the customer agrees with the trade-in price offered by Pre-owned Cars, the customer pays the difference between the price of the new car and the trade-in price. Suppose a customer buys a new car for $47,000 that has a dealer cost of$46,200. The same customer receives and accepts $11,000 for the trade-in of her used car and pays the balance of$36,000 in cash (ignoring taxes and license). In this case, New Cars shows a profit of $800 (before any commission to the salesperson). If the customer does not accept the trade-in value, she does not purchase the new car from Beckett. Once the deal is struck, the trade-in is then either sold by Pre-owned Cars to another customer at retail or is taken to auction where it is sold at wholesale. Continuing the preceding example, suppose the customer accepts$11,000 as the trade-in for her used car. The Pre-owned Cars Department can sell it on its used car lot for $15,000 at retail or sell it at auction for$12,000. If the trade-in is sold for $15,000, Pre-owned Cars would have a profit of$4,000 ($15,000 -$11,000). If it is sold at auction, Pre-owned Cars reports a profit of $1,000 ($12,000 - $11,000). Required: a. Describe some of the synergies that exist within Beckett. In other words, why does Beckett consist of three departments (New Cars, Pre-owned Cars, and Service) as opposed to just selling new cars, or just selling used cars, or just providing service? b. What potential conflicts of interest exist between the New Cars and Pre-owned Cars department managers? For example, describe how in pursuing their own self-interest, the manager of New Cars or Pre-owned Cars will behave in a way that harms the other manager. c. Suggest two alternative mechanisms to reduce the conflicts of interest you described in part ( b ). Essay Answer: Tags Choose question tag Metal Press Your firm uses return on assets (ROA) to evaluate investment centers and is considering changing the valuation basis of assets from historical cost to current value. When the historical cost of the asset is updated, a price index is used to approximate replacement value. For example, a metal fabrication press, which bends and shapes metal, was bought seven years ago for$522,000. The company will add 19 percent to this cost, representing the change in the wholesale price index over the seven years. This new, higher cost figure is depreciated using the straight-line method over the same 12-year assumed life (no salvage value). Required: a. Calculate depreciation expense and book value of the metal press under both historical cost and price-level-adjusted historical cost. b. In general, what is the effect on ROA of changing valuation bases from historical cost to current values? c. The manager of the investment center with the metal press is considering replacing it because it is becoming obsolete. Will the manager's incentives to replace the metal press change if the firm shifts from historical cost valuation to the proposed price-level-adjusted historical cost valuation?
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Executive Inn Sarah Adams manages Executive Inn of Toronto, a 200-room facility that rents furnished suites to executives by the month. The market is for people relocating to Toronto and waiting for permanent housing. Adams's compensation contains a fixed component and a bonus based on the net cash flows from operations. She seeks to maximize her compensation. Adams likes her job and has learned a lot, but she expects to be working for a financial institution within five years. Adams's occupancy rate is running at 98 percent, and she is considering a $10 million expansion of the present building to add more rental units. She has very good private knowledge of the future cash flows. In year 1, they will be$2 million and will decline $100,000 a year. The following table summarizes the expansion's cash flows: Based on the preceding data, Adams prepares a discounted cash flow analysis of the addition, which is contained in the following report: The discount factors are based on a weighted-average cost of capital of 12 percent, which accurately reflects the inn's nondiversifiable risk. Adams's boss, Kathy Judson, manages the Inn Division of Comfort Inc., which has 15 properties located around North America, including Executive Inn of Toronto. Judson does not have the detailed knowledge of the Toronto hotel/rental market as Adams does. Her general knowledge is not as detailed or as accurate as Adams's. (For the following questions, ignore taxes.) Required: a. The Inn Division of Comfort Inc. has a very crude accounting system that does not assign the depreciation of particular inns to individual managers. As a result, Adams's annual net cash flow statement is based on the operating revenues less operating expenses. Neither the cost of expansion nor depreciation on expanding her inn is charged to her operating statement. Given the facts provided so far, what decision do you expect her to make regarding building the$10 million addition? Explain why. b. Adams prepares the following report for Judson to justify the expansion project: Judson realizes that Adams's projected cash flows are most likely optimistic, but she does not know how optimistic or even whether or not the project is a positive net present value project. She decides to change Adams's performance measure used in computing her bonus. Adams's compensation will be based on residual income (EVA). Judson also changes the accounting system to track asset expansion and depreciation on the expansion. Adams's profits from operations will now be charged for straight-line depreciation of the expansion using a 10-year life (assume a zero salvage value). Calculate Adams's expected residual income from the expansion for each of the next 10 years. c. Based on your calculations in part ( b ), will Adams propose the expansion project? Explain why. d. Instead of using residual income as Adams's performance measure in part ( b ), Judson uses net cash flows from operations less straight-line depreciation. Will Adams seek to undertake the expansion? Explain why. e. Reconcile any differences in your answers for parts ( c ) and ( d ).