Chapter 19 – Strategic Performance Measurement—Investment Centers
19-31 (Continued-1)
In the current situation, we have:
Transfer Price:
Incremental Cost per unit = $500
the use of this transfer-pricing rule (a) maintained divisional autonomy,
and (b) provided the appropriate “signal” to internal decision-makers (i.e.,
buyers and sellers).
3. If the Fabrication (i.e., producing) Division had excess capacity, this
means that the opportunity cost associated with any internal transfers
would be zero. Thus, the transfer price, as specified by the general
transfer-pricing rule, would be:
Transfer Price = Incremental Cost per Unit + Opportunity Cost per Unit
situation that we state that the general transfer-pricing rule provides the
minimum transfer price, from the selling division’s standpoint.
4. As might be expected, the general transfer-pricing rule “works” in the
the rule is requirement to estimate opportunity costs. Under a perfectly
19-31 (Continued-2)
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Chapter 19 – Strategic Performance Measurement—Investment Centers
competitive market (as was assumed in this assignment), this may not be
much of a problem. However, under other market conditions, we know
that demand is partly a function of the quantity sold, both internally and
externally. (In other words, there are demand interactions that complicate
the chapter.
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Chapter 19 – Strategic Performance Measurement—Investment Centers
19-32 Transfer Pricing; Decision-Making (25 minutes)
1. Division A’s purchase decision from the overall firm perspective:
Purchase costs from outside 10,000 × $150 = $1,500,000
fixed costs are not affected by the decision, Division A should buy
inside from Division B for the benefit of the entire firm.
2. As above, but in addition, if Division A buys outside, Division B saves
an additional $200,000:
Purchase costs from outside 10,000 × $150 = $1,500,000
3. Assuming the outside price drops from $150 to $130:
Purchase costs from outside 10,000 × $130 = $1,300,000
Chapter 19 – Strategic Performance Measurement—Investment Centers
19-32 (continued)
19-24
P=150
P=200
V=140
O/S
A
B
B is at 100% capacity
Chapter 19 – Strategic Performance Measurement—Investment Centers
19-33 Transfer Pricing; Decision-Making (20 minutes)
Purchase costs from outside 10,000 × $150 = $1,500,000
Less: Savings in variable costs 10,000 × $140 = 1,400,000
Net Cost (Benefit) of External Purchase $ 100,000
B sales to other customers 10,000 × $215 = $2,150,000
The firm as a whole is better off (by $550,000) if Division A buys outside
since the contribution of Division B’s outside sales ($650,000) is greater
Education.
Chapter 19 – Strategic Performance Measurement—Investment Centers
19-34 Transfer Pricing; International Taxation (25 minutes)
The change in transfer price would simultaneously increase the
profitability of the foreign subsidiary where taxes are lower and reduce
Singapore
Subsidiary
United States
Subsidiary Total
INCOME PRIOR TO INCREASE IN TRANSFER PRICE
Revenues $2,500,000 $3,500,000 $6,000,000
Mfg. Costs 1,500,000 2,500,000 4,000,000
INCOME AFTER INCREASE IN TRANSFER PRICE
Revenues $3,000,000 $3,500,000 $6,500,000
Mfg. Costs 1,500,000 3,000,000 4,500,000
Gen. & Adm. Costs 350,000 200,000 550,000
Note: An equivalent, short-cut calculation would be:
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Chapter 19 – Strategic Performance Measurement—Investment Centers
PROBLEMS
19-35 Return on Investment (ROI); Different Measures for Total Assets (50
minutes)
1. Net book value (NBV) of fixed assets for each division (000s):
HEALTHCARE: $70 × 11 years remaining useful life = $770
COSMETICS: $70 × 9 years remaining useful life = $630
ROI using historical cost of divisional assets:
The COSMETICS Division is more profitable than the HEALTHCARE
Division, based on ROI calculated using net book value (NBV) of
divisional fixed assets (plus the current balance sheet value of current
assets).
2. a.
Gross Book Value (GBV) for each division:
ROI:
b. (GBV at historical cost) × (construction cost index in 2016 ÷
construction cost in year of construction):
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Chapter 19 – Strategic Performance Measurement—Investment Centers
19-35 (continued-1)
c. (Current NBV of fixed assets) ×(construction cost index in 2016 ÷
construction cost in year of construction)
d. ROI Based on Current Replacement Cost of Fixed Assets (plus
current book value of current assets):
3. a. The best measure for evaluating the manager is replacement cost, as
it corresponds to the “going-concern” value of the investment. The
objective is to identify a measure of investment that fairly reflects the
productive capacity of the assets. Often, net book value falls much
faster than the productive capability of the assets, and thus, the ROI
with the older assets overstates the profitability of the unit. The use of
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Chapter 19 – Strategic Performance Measurement—Investment Centers
19-35 (continued-2)
The advantages of the replacement cost measure are fairness, since it
avoids the age bias issues associated with the net book value
measure, and motivation, since it reflects the current value of the
b. The evaluation of the division should use replacement cost for the
same reasons as explained in (a) above. The only difference here is
when either division might be sold or relocated, in which case the
liquidation value is relevant. Top management can also look at the
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19-36 Return on Investment (ROI) and Incentive/Goal-Congruency Issues;
Spreadsheet Application (60-75 Minutes)
3. The depreciation calculation, and therefore the year-by-year operating
incomes for the proposed investment, are identical in (1) and in (2). That is,
asset base (level of investment) was measured results in vastly different
year-to-year ROIs for the two specified alternatives. These differences
introduce ambiguity in the decision-making process (unlike the use of the
NPV criterion).
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