PROBLEM 13-41 (40 MINUTES)
Year
Income
Before
Depreciation
Annual
Depreciation
Income
Net of
Depreciation
Average
Net Book
Value*
ROI
Based
on
Net Book
Value†
Average
Gross
Book
Value
ROI
Based
on
Gross
Book
Value
1
$150,000
$200,000
$(50,000)
$400,000
—
$500,000
—
2
150,000
120,000
30,000
240,000
12.5%
500,000
6.0%
3
150,000
78,000
144,000
54.2%
500,000
4
150,000
96,000
118.5%
500,000
5
150,000
96,000
355.6%
500,000
†ROI rounded to the nearest tenth of 1 percent.
1.
This table differs from Exhibit 13-3 in that ROI rises even more steeply across time than
2.
One potential implication of such an ROI pattern is a disincentive for new investment. If
a proposed capital project shows a loss or very low ROI in its early years, a manager
Chapter 13 – Investment Centers and Transfer Pricing
PROBLEM 13-42 (40 MINUTES)
Based on Net Book Value
Based on Gross Book Value
Year
Income
Before
Depreciation
Annual
Depreciation
Income
Net of
Depreciation
Average
Net Book
Value*
Imputed
Interest
Charge†
Residual
Income
Average
Gross
Book
Value
Imputed
Interest
Charge†
Residual
Income
1
$150,000
$100,000
$50,000
$450,000
$45,000
$ 5,000
$500,000
$50,000
0
2
150,000
100,000
50,000
350,000
35,000
15,000
500,000
50,000
0
3
150,000
100,000
50,000
250,000
25,000
25,000
500,000
50,000
0
4
150,000
100,000
50,000
150,000
15,000
35,000
500,000
50,000
0
5
150,000
100,000
50,000
50,000
45,000
50,000
0
*Average net book value is the average of the beginning and ending balances for the year in net book value.
†Imputed interest charge is 10 percent of the average book value, either net or gross.
PROBLEM 13-43 (30 MINUTES)
1. Sales margin: income divided by sales revenue.
Capital turnover: sales revenue divided by invested capital
Return on investment: income divided by invested capital (or sales margin x capital
turnover).
2. Strategy (a): Income will be reduced to $450,000 because of the loss, and invested
capital will fall to $8,910,000 from the disposal. ROI = $450,000 ÷ $8,910,000, or
PROBLEM 13-43 (CONTINUED)
4. Anderson Manufacturing ROI: ($4,500,000 – $3,600,000) ÷ $7,500,000 = 12%
Palm Beach Enterprises ROI: ($6,750,000 – $6,180,000) ÷ $7,125,000 = 8%
From the preceding calculations, both investments appear attractive given the
current state of affairs (i.e., the Hardware Division’s current ROI of 6%). However, if
PROBLEM 13-44 (35 MINUTES)
1. The weighted-average cost of capital (WACC) is defined as follows:
equity
of value
Market
capital
equity
ofCost
debt of
value
Market
capital
debt
ofcost
tax–After
average
–Weighted
+
Chapter 13 – Investment Centers and Transfer Pricing
PROBLEM 13-44 (CONTINUED)
2. The three divisions’ economic–value-added measures are calculated as follows:
Division
After-Tax
Operating
Income
(in millions)
−
Total
Assets
(in
millions)
−
Current
Liabilities
(in
millions)
WACC
=
Economic
Value
Added
(in millions)
PROBLEM 13-45 (35 MINUTES)
1. The weighted-average cost of capital (WACC) is defined as follows:
equity of
value
Market
capital
equity
ofCost
debt of
value
Market
capital
debt of
cost tax–After
average–Weighted
+
2. The economic value added (EVA) is defined as follows:
−−=
average–Weighted
Investment
Investment
scenter’ Investment
Economic
For Cape Cod Lobster Shacks, Inc., we have the following calculations of EVA for each of
the company’s divisions.
PROBLEM 13-46 (25 MINUTES)
1. The Birmingham divisional manager will likely be opposed to the transfer. Currently,
2. Although Tampa is receiving a $50 “price break” on each unit purchased from
Birmingham, the $1,500 transfer price would probably be deemed too high. The
3. Although top management desires to introduce the positioning system, it should not
lower the price to make the transfer attractive to Tampa. MTI uses a responsibility
4. MTI would benefit more if it sells the diode reducer externally. Observe that the
Produce Diode;
Sell Externally
Produce Diode;
Transfer; Sell
Positioning System
Sales revenue ………………..
$1,550
$2,800
Less: Variable cost::
Contribution margin ……….
$ 550
$ 460
PROBLEM 13-47 (40 MINUTES)
1.
a.
Transfer price
=
outlay cost + opportunity cost
=
$130 + $30 = $160
b.
Transfer price
=
standard variable cost + (10%)(standard variable cost)
=
$130 + (10%) ($130) = $143
Note that the Frame Division manager would refuse to transfer at this price.
2.
a.
Transfer price
=
outlay cost + opportunity cost
=
$130 + 0 = $130
b.
When there is no excess capacity, the opportunity cost is the forgone
c.
Fixed overhead per frame (125%)($40) = $50
+ (10%)(variable cost + fixed overhead per frame)
=
$130 + $50 + [(10%)($130 + $50)]
=
$198
d.
Incremental revenue per window …………………………….
$310
Incremental cost per window, for Weathermaster
Window Company:
Direct material (Frame Division) ………………………….
$30
Direct labor (Frame Division) ………………………………
40
Variable overhead (Frame Division) ……………………..
60
Direct material (Glass Division) …………………………..
60
Direct labor (Glass Division) ……………………………….
30
Variable overhead (Glass Division) ………………………
Total variable (incremental) cost………………………….
Incremental contribution per window in special order
for Weathermaster Window Company …………………..
Chapter 13 – Investment Centers and Transfer Pricing
PROBLEM 13-47 (CONTINUED)
e.
Incremental revenue per window …………………………….
$ 310
Incremental cost per window, for the Glass Division:
Transfer price for frame [from requirement 2(c)] …..
$198
Direct material (Glass Division) …………………………..
Direct labor (Glass Division) ……………………………….
Variable overhead (Glass Division) ………………………
Total incremental cost ………………………………………..
f.
One can raise an ethical issue here to the effect that a division manager should
always strive to act in the best interests of the whole company, even if that action
3.
The use of a transfer price based on the Frame Division’s full cost has caused a cost
PROBLEM 13-48 (40 MINUTES)
1. Among the reasons transfer prices based on total actual costs are not appropriate as a
divisional performance measure are the following:
2. Using the market price as the transfer price, the contribution margin for both the
Mining Division and the Metals Division is calculated as follows:
Mining
Division
Metals
Division
Selling price …………………………………………………………………..
Less: Variable costs:
$ 270
$ 450
PROBLEM 13-48 (CONTINUED)
3. If RIRC instituted the use of a negotiated transfer price that also permitted the
divisions to buy and sell on the open market, the price range for toldine that would
be acceptable to both divisions would be determined as follows.
4. General transfer-pricing rule:
Transfer price = outlay cost + opportunity cost
= ($36 + $48 + $72)* + ($114 – $15) **
5. A negotiated transfer price is probably the most likely to elicit desirable management
behavior, because it will do the following:
PROBLEM 13-49 (30 MINUTES)
1. If the transfer price is set equal to the U.S. variable manufacturing cost, Delta
Telecom will make $98.40 per circuit board:
U.S. operation:
Sales revenue (transfer price)………………………………
$ 390.00
Less: Variable manufacturing cost………………………..
390.00
Contribution margin………………………………………….
$ —
Sales revenue……………………………………
$1,080.00
Less: Transfer price…………………………….
$390.00
60.00
39.00
834.00
Income before tax……………………………….
$ 246.00
Less: Income tax expense ($246.00 x 60%)..
147.60
Income after tax…………………………………
$ 98.40
2. If the transfer price is set equal to the U.S. market price, Delta will make $117.60 per
circuit board: $72.00 + $45.60 = $117.60. The U.S. market price is therefore more
attractive as a transfer price than the U.S. variable manufacturing cost.
U.S. operation:
Sales revenue………………………………………………….
$ 510.00
Less: Variable manufacturing cost………………………..
390.00
Income before tax…………………………………………….
$ 120.00
Less: Income tax expense ($120.00 x 40%)………………
48.00
Income after tax……………………………………………….
$ 72.00
German operation:
Sales revenue……………………………………
$1,080.00
Less: Transfer price…………………………….
$510.00
60.00
51.00
966.00
Income before tax……………………………….
$ 114.00
Less: Income tax expense ($114.00 x 60%)..
68.40
Income after tax…………………………………
$ 45.60