On January 1, Intergen, Inc., invests $200,000 for a 40 percent interest in Ryan, a new joint venture withtwo other partners each investing $150,000 for 30 percent interests. Intergen plans to sell all of its production to Ryan, which will resell the inventory to retail outlets. The equity partners agree that Ryan will buy inventory only from Intergen. Also, Intergen plans to use the equity method for financial reporting.
During the year, Intergen expects to incur costs of $850,000 to produce goods with a final retail market value of $1,200,000. Ryan projects that, during this year, it will resell three-fourths of these goods for $900,000. It should sell the remainder in the following year.
The equity partners plan a meeting to set the price Intergen will charge Ryan for its production. One partner suggests a transfer price of $1,025,000 but is unsure whether it will result in an equitable return across the equity holders. Importantly, Intergen agrees that its total rate of return (including its own operations and its investment in Ryan) should be equal to that of the other investors' return on their investments in Ryan. All agree that Intergen's value including its investment in Ryan is $1,000,000.
Required
1. Create an Excel spreadsheet analysis showing the following:
- Projected income statements for Intergen and Ryan. Formulate the statements to do the following:
- Link Ryan's cost of goods sold to Intergen's sales (use a starting value of $1,025,000 for Intergen's sales).
- Link Intergen's equity in Ryan's earnings to Ryan's net income (adjusted for Intergen's gross profit rate Ryan's ending inventory 40 percent ownership percentage).
- Be able to change Intergen's sales and see the effects throughout the income statements of Ryan and Intergen. Note that the cost of goods sold for Intergen is fixed.
- The rate of return for the two 30 percent equity partners on their investment in Ryan.
- The total rate of return for Intergen based on its $1,000,000 value.
2. What transfer price will provide an equal rate of return for each of the investors in the first year of operation? (Hint: Under Excel's Tools menu, use the Goal Seek or Solver capability to produce a zero difference in rates of return across the equity partners by changing the cell that contains Intergen's sales.)