PART I - Buffay Book Company has two divisions: The Brick and Mortar division sells books through more than 100 bookstores throughout the United States; the Internet division was formed 18 months ago and sells books via the Internet. Data for the past year are:
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Brick and Mortar Division
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Internet Division
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Operating assets
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$172,200,000
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$14,400,000
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Total revenues
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285,600,000
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86,500,000
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Net Operating income
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27,740,000
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985,000
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Cost of capital
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13%
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15%
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# of full-time equipment employees
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900
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360
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1. Compute the return on investment (ROI) of each division, and break down each division's ROI into components that measure operating efficiency and the efficiency in asset utilization. Based on the information above, would you expect any difference between the ROIs of each division?
2. Presented below are some average financial statistics (over the past three years) of two of Buffay's competitors-Bing Bookstore, a largely brick-and-mortar book retailer, and Rainforest.com, which sells books (and all sorts of other things) over the internet. Given these data, how would you suggest improving the ROI of each division of Buffay Book Company? What other information would be helpful in measuring the performance of each division?
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Bing Bookstore
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Rainforest.com
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Net operating profit margin
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0.0%
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1.8%
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Operating asset turnover
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3.75
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4.63
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3. Now, evaluate the two divisions in terms of residual income.
4. The CFO of Buffay has solicited feedback on how to improve the system of performance measurement at the company, and has received the suggestions below. Evaluate each of the following proposals. Explain how these may (or may not) improve the performance measurement and evaluation system.
a) Construct and implement two balanced scorecards, one for each division, and measure performance of both managers.
b) Include a total-company financial performance metric (such as total-company ROI) in each manager's compensation contract.
c) Evaluate the performance of each manager subjectively.
d) Establish a belief system by articulating the company's mission statement (which has not been created).
5. Assume that the CFO has chosen to prepare two balanced scorecards, one for each division. What measures would each division include in (1) the customer perspective, and (2) the internal process perspective? Give at least two measures under each perspective for each division, and briefly explain why you chose those measures. Identify the potential links between the customer and internal processes measures that you've chosen.
PART II - Regina Phalange Organics Company manufactures vitamins. In its budget, the company plans to produce 2,400 bottles of Vitamin C each month. The company uses the following standards for producing one bottle of Vitamin C; each bottle contains 100 tablets, and each tablet contains 500 mg. of Vitamin C.
Materials - 52,500 mg @ $0.0001 per mg.
Labor - 6 minutes @ $12 per hour
For the most recent month, the company's standard number of direct labor hours allowed for actual production was 250 hours. The ending inventory of unprocessed Vitamin C increased by 10,000 grams. Following is the variance data for the month:
Materials price variance - $2,800 favorable
Materials usage variance - $1,875 unfavorable
Labor rate variance - $188 unfavorable
Labor efficiency variance - $180 favorable
1. What was the actual quantity of materials (in mg) used during the most recent month?
2. What was the actual price paid for materials (per mg) during the most recent month?
3. What was the actual quantity of labor (in hours) used during the most recent month?
4. What was the actual price paid (per hour) for labor during the most recent month?
PART III - Tomato beetles, a major pest to the tomato crop, are now being controlled by toxic pesticides. The firm RachelBioScience invested $5 million in R&D over the last five years to produce a genetically engineered, patented microbe, Smelly Kat (SK)-27, which controls tomato beetles in an environmentally safe way. Rachel built the Chandler Plant with capacity to produce 10,000 pounds of SK-27 per month. The Chandler Plant cost $12 million and has a 10-year life. SK-27 has a variable cost of $3 per pound. Fixed costs are $50,000 per month for such costs as plant management, insurance, taxes, and security. Plant depreciation is not included in the $50,000 fixed cost. The Chandler Plant is evaluated as an autonomous profit center.
SK-27 is sold for $30 per pound. The Chandler Plant is currently selling 9,000 pounds per month to tomato farmers. The following table summarizes the full cost of producing SK-27:
Depreciation per month ($12 million ÷ 120 months) $100,000
Other fixed costs 50,000
Total fixed costs $150,000
÷ Capacity per month (pounds) 10,000
Fixed costs per unit of capacity (pound) $15.00
Variable costs per pound 3.00
Full cost per pound $18.00
Another division of Rachel, Home Life, wants to secure 1,500 pounds per month of SK-27 that it will process further into a consumer product, Tomato Safe, for gardeners. Home Life is willing to pay an internal transfer price of $5 per pound. Home Life will incur an additional $4 of variable cost per pound of SK-27 in reducing the potency of SK-27 to make Tomato Safe more appropriate for home gardeners. Tomato Safe will sell for $20 per pound of SK-27.
1. If the Chandler Plant had excess capacity, what would be the minimum transfer price that the division would accept?
2. As it currently stands, determine (a) the minimum price at which the Chandler Plant would consider acceptable for a transfer to take place, and (b) the maximum price that Home Life would be willing to pay for each pound of SK-27.
3. Assume that both parties agreed on a transfer price of $8 per pound. Would it be beneficial for Rachel for the transfer to take place? Provide quantitative and qualitative support.
4. The CEO of Rachel suggests the use of dual transfer prices, such that transfers out of the SK-27 plant be recorded by the Chandler Plant at full cost, while transfers into the Home Life be purchased (and recorded) at $5 for each pound transferred. What are the pros and cons of this suggestion?
PART IV - Phoebe Inc. has the following financial data for the current year (millions):
Earnings before taxes - $15.5
R&D expenditures - $6.0
Total invested capital (excluding R&D assets) - $100.0
Weighted average cost of capital - 12%
Tax rate - 30%
1. R&D expenditures have been increasing at a constant rate of $500,000 each year for the past 5 years. Calculate Phoebe's EVA for the current year after capitalizing the current year and previous years' R&D and amortizing the capitalized R&D balance over 3 years. Assume all R&D spending occurs at the beginning of the year, and that EVA is calculated on the basis of beginning operating assets. Also assume that current liabilities are immaterial.
2. How would capitalizing and amortizing R&D expenditures instead of expensing R&D affect the incentive for managers approaching retirement to under spend on R&D at Phoebe?