ASSIGNMENT BRIEF (Par t A required)
PART A
1. Bounce Ltd. is a leading manufacturer and retailer of one type of product, ProdX. It has divided its operations into three divisions, i.e.:
- Division A: supply rubber
- Division B: compound rubber with chemicals to produce finished rubber
- Division C: produce ProdX
Division B has offered to buy 50,000 meters of rubber per annum from Division A at a price of £40 per meter.
Although the total capacity of the Division A is 125,000meters per annum, its normal production levels are 105,000 meters per annum. The production costs per meter (under normal production of 105,000 meter) of rubber are as follows:
Direct material £15
Direct Labour £12
Variable Overheads £5
Fixed Overheads (i.e. Total Fixed Overheads/105,000) £15
Total £47
Division A has been selling its finished product, i.e. rubber, to outside buyers at £55 per meter. Division B has been buying rubber from outside suppliers at £52 per meter.
Required:
a) Presuming each divisional manager aims to optimise their division's financial performance; discuss, with reason(s), whether the manager of Division A will accept a purchase offer of £40 per meter. Calculate the financial implication of accepting or rejecting the offer on Division A.
b) Will the internal transfer result in a financial gain or loss for the company? Explain the reason(s) behind this gain or loss. Calculate the financial implication of the internal transfer on Bounce Ltd.
For parts a) and b) please use numerical evidence to justify your answer.
c) If Division A has surplus capacity identify, with reasons, the maximum transfer price Division B would be willing to pay and the minimum transfer price Division A would be willing to accept.
d) If Division A loses its surplus capacity, will Bounce Ltd. benefit from future internal transfers?
2. Division C of Bounce Ltd. currently purchases a fixed quantity of finishedrubber from Division B at a price of £70 per meter. The manager of Division B is considering the prospects of raising the prices of finished rubber from £70 per meter to £82 per meter; a proposal which is strongly opposed by Division C.
Division C is able to purchase finished rubber at £75 per meter in the open market.
The cost of production per meter in the Division B is as follows:-
Direct Material £45
(Includes £40 paid to Division A + other direct material)
Direct Labour £15
Variable Overheads £2
Fixed Overhead per meter£10
Total £72
If Division B stopped supplying rubber to Division C, they will be able to save one-fourth of the Fixed Overheads per meter. Currently Division B does not have any alternative use for it spare capacity.
Required:
a) Calculate the maximum transfer price Division C would be willing to pay and the minimum transfer price Division B would be willing to accept?
b) From the perspective of Bounce Ltd., examine whether Division C should purchase steel from Division B or if it should purchase from the open market?
Part B
Bounce Ltd. ProdX is sold through two other divisions i.e. West Division and East Division. These two selling divisions are treated as investment centres. Excerpts from their financial statements are as follows:
West Division East Division
| |
West Division
|
East Division
|
|
Sales Revenue
|
£1,000,000
|
£1250,000
|
|
Total Variable Costs
|
-£200,000
|
-£375,000
|
|
Total Fixed Costs
|
-£620,000
|
-£722,000
|
|
Operating Profits
|
£180,000
|
£153,000
|
|
Total Assets
|
£750,000
|
£900,000
|
Required:
a) Calculate Residual Income (RI) and Return on Investment (ROI) for the West division and East division. Briefly comment on the relative performance of the two divisions using the RI and ROI. You may assume the notional rate of interest is 10%. (5 marks)
b) Explain the distinctive features of Residual Income, Return on Investment and Net Present Value in measuring financial performance.
Critically analyse the strengths and weaknesses of each measure.
Comment on the problems that may be involved in comparing divisional performance.
Discuss the approaches that can be used to avoid dysfunctional behaviour which is motivated by accounting-based performance targets.
PART C
Decision tree, Expected value and Maximax, Maximin and Regret criterion can be used for decision-making under conditions of risk and uncertainty. The managing director of Bounce Ltd. has asked you to explain how each method of the above can be applied in decision-making and comment on the strengths and limitations of each method. (25 marks)
Presentation - marks will be awarded for producing a professional report (suitable for use in a business situation such as that described above).