Problem 1 - Return on Investment (ROI) and Residual Income
"I know headquarters wants us to add that new product line," said Fred Halloway, manager of Kirsi Products' East Division. "But I want to see the numbers before I make a move. Our division's return on investment (ROI) has led the company for three years, and I don't want any letdown."
Kirsi Products is a decentralized wholesaler with four autonomous divisions. The divisions are evaluated on the basis of ROI, with year-end bonuses given to divisional managers who have the highest ROI. Operating results for the company's East Division for last year are given below:
|
Sales
|
$27,000,000
|
|
Variable expenses
|
14,000,000
|
|
Contribution margin
|
13,000,000
|
|
Fixed expenses
|
10,759,000
|
|
Net operating income
|
$2,241,000
|
|
Divisional operating assets
|
$5,400,000
|
The company had an overall ROI of 18% last year (considering all divisions). The company's East Division has an opportunity to add a new product line that would require an investment of $3,200,000. The cost and revenue characteristics of the new product line per year would be as follows:
|
Sales
|
$ 9,920,000
|
|
Variable expenses
|
65% of sales
|
|
Fixed expenses
|
$ 2,777,600
|
Required:
1. Compute the East Division's ROI for last year; also compute the ROI as it would appear if the new product line is added.
2. Suppose that the company's minimum required rate of return on operating assets is 15% and that performance is evaluated using residual income.
a. Compute the East Division's residual income for last year; also compute the residual income as it would appear if the new product line is added.
Problem 2 - Make or Buy a Component
Royal Company manufactures 27,000 units of part R-3 each year for use on its production line. At this level of activity, the cost per unit for part R-3 is:
|
Direct materials
|
$4.10
|
|
Direct labor
|
7.00
|
|
Variable manufacturing overhead
|
3.90
|
|
Fixed manufacturing overhead
|
12.00
|
|
Total cost per part
|
$27.00
|
An outside supplier has offered to sell 27,000 units of part R-3 each year to Royal Company for $48.00 per part. If Royal Company accepts this offer, the facilities now being used to manufacture part R-3 could be rented to another company at an annual rental of $788,000. However, Royal Company has determined that $8 of the fixed manufacturing overhead being applied to part R-3 would continue even if part R-3 were purchased from the outside supplier.
Required:
a. What is the total relevant cost of making the product?
b. What is the total relevant cost of buying the product?
c. What is the opportunity cost of making instead of buying?
d. How much profits will increase or decrease if the outside supplier's offer is accepted?
Problem 3 - Special Order
Glade Company produces a single product. The costs of producing and selling a single unit of this product at the company's current activity level of 7,300 units per month are:
|
Direct materials
|
$1.70
|
|
Direct labor
|
$2.00
|
|
Variable manufacturing overhead
|
$.60
|
|
Fixed manufacturing overhead
|
$3.25
|
|
Variable selling and administrative expenses
|
$1.00
|
|
Fixed selling and administrative expenses
|
$1.00
|
The normal selling price is $25 per unit. The company's capacity is 9,500 units per month. An order has been received from a potential customer overseas for 2,200 units at a price of $22.00 per unit. This order would not affect regular sales.
Required:
1. If the order is accepted, by how much will monthly profits increase or decrease? (The order would not change the company's total fixed costs.)
2. Assume the company has 500 units of this product left over from last year that are inferior to the current model. The units must be sold through regular channels at reduced prices. What unit cost is relevant for establishing a minimum selling price for these units?