Problem: Performance Evaluation

Division A of Gwinnett Company, produces wedges. Division Z's manager has discretion in pricing and other decisions. Division Z is expected to generate a minimum required rate of return of at least 18% on its operating assets. The division has average operating assets of $900,000. The wedges are sold for $8 each. Variable costs are $3 per wedges, and fixed costs total $390,000 per year. The division has a capacity of 120,000 wedges each year.

How many wedges must Division Z sell each year to generate the desired rate of return on its assets?

Number of wedges: _110400__________
Required rate of return on assets= 900000*18%= 162000
Net income required 162000
Fixed assets 390000
Required contribution 552000
Let x be number of unit sold
(8-3)
X= 110400 units

Hence 110400 wedges must division z sell each year to generate the desire rate of return

• Assume that Division Z's current ROI equals the minimum required rate of 18%. The divisional manager wants to increase the selling price per wedge by 5%. Market studies indicate that an increase in the selling price would cause sales to drop by 15,000 units each year. However, operating assets could be reduced by $65,000 due to decreased needs for accounts receivable and inventory. Compute the new ROI if these changes are made.

ROI: __15%________
Sales (95400*8.40) 801360
Less Varible costs 286200
Contribution Margin 515160
Fixed Costs -390000
Net Income 125160
Note: Revised Net Income/Revised Operating Assets
/(900000-65000)
%

• Refer to the original data (i.e. used for question A.). Assume again that the Division's current ROI equals the required rate of 18%. Rather than increase the selling price, the sales manager want to reduced the selling price by 10%. Market studies indicate that this would fill the plant to capacity. In order to carry the greater level of sales, however, operating assets would increase by $28,000. Compute ROI if these changes are made.