Q1. Calculating Residual Income
Forchen, Inc., provided the following information for two of its divisions for last year:
|
Small Appliances
Division
|
Cleaning Products
Division
|
|
Sales
|
$34,640,000
|
$31,300,000
|
|
Operating income
|
2,592,000
|
1,252,700
|
|
Operating assets, January 1
|
6,394,000
|
5,700,000
|
|
Operating assets, December 31
|
7,480,000
|
6,880,000
|
Forchen, Inc., requires an 8 percent minimum rate of return.
Required:
1. Calculate residual income for the Small Appliances Division.
2. Calculate residual income for the Cleaning Products Division.
3. What if the minimum required rate of return was 9 percent? How would that affect the residual income of the two divisions?
Small Appliances Division residual income would be -
Cleaning Products Division residual income would be -
Problem 2 - Determining Market-Based and Negotiated Transfer Prices
Carreker, Inc., has a number of divisions, including the Alamosa Division, producer of surgical blades, and the Tavaris Division, a manufacturer of medical instruments.
Alamosa Division produces a 2.8 cm steel blade that can be used by Tavaris Division in the production of scalpels. The market price of the blade is $23. Cost information for the blade is:
|
Variable product cost
|
$9.70
|
|
Fixed cost
|
5.30
|
|
Total product cost
|
$15.00
|
Tavaris needs 15,000 units of the 2.8 cm blade per year. Alamosa Division is at full capacity (89,000 units of the blade).
Required:
1. If Carreker, Inc., has a transfer pricing policy that requires transfer at market price, what would the transfer price be?
Do you suppose that Alamosa and Tavaris divisions would choose to transfer at that price?
2. Now suppose that Carreker, Inc., allows negotiated transfer pricing and that Alamosa Division can avoid $1.80 of selling and distribution expense by selling to Tavaris Division. Which division sets the minimum transfer price, and what is it? Round your answers to the nearest cent, if needed.
Which division sets the maximum transfer price, and what is it?
Do you suppose that Alamosa and Tavaris divisions would choose to transfer somewhere in the bargaining range?
3. What if Alamosa Division plans to produce and sell only 63,000 units of the 2.8 cm blade next year? Which division sets the minimum transfer price, and what is it? Round your answers to the nearest cent, if needed.
Which division sets the maximum transfer price, and what is it?
Do you suppose that Alamosa and Tavaris divisions would choose to transfer somewhere in the bargaining range?
Problem 3 - Calculating EVA
Brewster Company manufactures elderberry wine. Last year, Brewster earned operating income of $186,000 after income taxes. Capital employed equaled $3 million. Brewster is 45 percent equity and 55 percent 10-year bonds paying 6 percent interest. Brewster's marginal tax rate is 40 percent. The company is considered a fairly risky investment and probably commands a 13-point premium above the 4 percent rate on long-term Treasury bonds.
Jonathan Brewster's aunts, Abby and Martha, have just retired, and Brewster is the new CEO of Brewster Company. He would like to improve EVA for the company. Compute EVA under each of the following independent scenarios that Brewster is considering.
Required:
Use a spreadsheet to perform your calculations and round all interim and percentage figures to four decimal places. If the EVA is negative, enter your answer as a negative amount.
1. No changes are made; calculate EVA using the original data.
2. Sugar will be used to replace another natural ingredient (atomic number 33) in the elderberry wine. This should not affect costs but will begin to affect the market assessment of Brewster Company, bringing the premium above long-term Treasury bills to 11 percent the first year and 8 percent the second year. Calculate revised EVA for both years.
3. Brewster is considering expanding but needs additional capital. The company could borrow money, but it is considering selling more common stock, which would increase equity to 70 percent of total financing. Total capital employed would be $3,100,000. The new after-tax operating income would be $390,000. Using the original data, calculate EVA. Then, recalculate EVA assuming the materials substitution described in Requirement 2. New after-tax income will be $390,000, and in Year 1, the premium will be 11 percent above the long-term Treasury rate. In Year 2, it will be 8 percent above the long-term Treasury rate. (Hint: You will calculate three EVAs for this requirement.)
Problem 4 - Exploiting Internal Linkages
Woodruff Company is currently producing a snowmobile that uses five specialized parts. Engineering has proposed replacing these specialized parts with commodity parts, which will cost less and can be purchased in larger order quantities. Current activity capacity and demand (with specialized parts required) and expected activity demand (with only commodity parts required) are provided.
|
Activities
|
Activity Driver
|
Activity Capacity
|
Current Activity Demand
|
|
Material usage
|
Number of parts
|
230,000
|
230,000
|
|
Installing parts
|
Direct labor hours
|
45,000
|
45,000
|
|
Purchasing parts
|
Number of orders
|
37,600
|
32,148
|
Additionally, the following activity cost data are provided:
Material usage: $29 per specialized part used; $17 per commodity part; no fixed activity cost.
Installing parts: $15 per direct labor hour; no fixed activity cost.
Purchasing parts: Four salaried clerks, each earning a $44,000 annual salary; each clerk is capable of processing 9,400 purchase orders. Variable activity costs: $1.50 per purchase order processed for forms, postage, etc.
Required:
1. Calculate the cost reduction produced by using commodity parts instead of specialized parts. Enter your answers as positive amounts.
2. Suppose that 50,000 units are being produced and sold for $8,800 per unit and that the price per unit will be reduced by the per-unit savings. What is the new price for the configured product? If required, round your intermediate calculations and final answer to the nearest cent.
3. What if the expected activity demand for purchase orders was 8,500? How would this affect the answers to Requirements 1 and 2? If required, round your intermediate calculations and final answers to the nearest cent.
Problem 5 - Activity-Based Life-Cycle Costing
Kagle design engineers are in the process of developing a new "green" product, one that will significantly reduce impact on the environment and yet still provide the desired customer functionality. Currently, two designs are being considered. The manager of Kagle has told the engineers that the cost for the new product cannot exceed $550 per unit (target cost). In the past, the Cost Accounting Department has given estimated costs using a unit-based system. At the request of the Engineering Department, Cost Accounting is providing both unit- and activity-based accounting information (made possible by a recent pilot study producing the activity-based data).
Unit-based system:
Variable conversion activity rate: $110 per direct labor hour
Material usage rate: $30 per part
ABC system:
Labor usage: $15 per direct labor hour
Material usage (direct materials): $20 per part
Machining: $85 per machine hour
Purchasing activity: $170 per purchase order
Setup activity: $3,000 per setup hour
Warranty activity: $650 per returned unit (usually requires extensive rework)
Customer repair cost: $40 per repair hour (average)
Activity and Resource Information (annual estimates)
|
Design A
|
Design B
|
|
Units produced
|
25,000
|
25,000
|
|
Direct material usage
|
320,000 parts
|
295,000 parts
|
|
Labor usage
|
50,000 hours
|
120,000 hours
|
|
Machine hours
|
50,000
|
60,000
|
|
Purchase orders
|
2,500
|
2,000
|
|
Setup hours
|
750
|
200
|
|
Returned units
|
1,300
|
400
|
|
Repair time (customer)
|
2,400
|
500
|
Required:
1. Select the lower-cost design using unit-based costing.
Are logistical and post-purchase activities considered in this analysis?
2. Select the lower-cost design using ABC analysis.
3. What if the post-purchase cost was an environmental contaminant and amounted to $15 per unit for Design A and $40 per unit for Design B? Compute the Post-purchase cost for each design.
Assume that the environmental cost is borne by society. Now which is the better design?
Attachment:- Problem 4.rar