Exam 13: Investment Centers and Transfer Pricing

The income calculation for a division manager's ROI should be based on profit margin traceable to the division.

Economic value added uses a firm's weighted-average cost of capital.

Deborah Lewis, general manager of the Northwest Division of Berkshire Enterprises, has significant authority over pricing decisions as well as programs that involve cost reduction/control. The data that follow relate to upcoming divisional operations: Average invested capital: $15,000,000 Annual fixed costs: $3,900,000 Variable cost per unit: $80 Number of units expected to be sold: 120,000 Required: A. Top management will promote Lewis if she can earn a 14% return on investment for the year. What unit selling price should she establish to get her promotion? B. Independent of part "A," assume the unit selling price is $132 and that Berkshire has a 16% imputed interest charge. Top management will promote Lewis to corporate headquarters if her division can generate $200,000 of residual income. If Lewis desires to move to corporate, what must the division do to the amount of annual fixed costs incurred? Show your calculations.

Return on investment (ROI) is a very popular tool to evaluate performance. The measurement of ROI is dependent, in part, on whether fixed assets are valued at acquisition cost or net book value. List several advantages of acquisition cost and net book value as ways to value long-lived assets.

Midtown Division, which is part of Courtyard Enterprises, recently reported a sales margin of 30% and an ROI of 21%. Required: A. Briefly define sales margin, capital turnover, and return on investment. B. Assume that Midtown has residual income of $220,000 and that Courtyard uses an imputed interest rate of 10%. Compute Midtown's capital turnover and invested capital. C. In answering this question, ignore the assumptions stated in in requirement "B," and your answer. Instead, assume that Midtown's invested capital amounted to $2,500,000. On the basis of this information, calculate income and sales revenue.

Walker, Inc. has a Pennsylvania-based division that produces electronic components, with a very strong domestic market for circuit no. 222. The variable production cost is $140, and the division can sell its entire output for $190. Walker is subject to a 30% income tax rate. Alternatively, the Pennsylvania division can ship the circuit to a division that is located in Mississippi, to be used in the manufacture of a global positioning system (GPS). Information about the global positioning system and Mississippi's costs follow. Selling price: $380 Circuit shipping and handling fees to Mississippi: $10 Labor, overhead, and additional material costs of GPS: $120 Required: A. Assume that the transfer price for the circuit was $160. How would Pennsylvania's divisional manager likely react to a corporate decision to transfer the circuits to Mississippi? Why? B. Calculate Pennsylvania income, Mississippi income, and income for the company as a whole if the transfer took place at $160 per circuit. C. Assuming that transfers took place at a price higher than $160, would the revised price increase, decrease, or have no effect on Walker's income? Briefly explain. D. Assume that Walker moved its GPS production facility to a division located in Germany, which is subject to a 45% tax rate. The transfer took place at $180. Shipping fees (absorbed by the overseas division) doubled to $20; the German division paid an import duty equal to 10% of the transfer price; and labor, overhead, and additional material costs were $150 per GPS. If the German selling price of the GPS amounted to $450, calculate Pennsylvania income, German income, and income for Walker as a whole. E. Suppose that U.S. and German tax authorities allowed some discretion in how transfer prices were set. Given the difference in tax rates, should Walker attempt to generate the majority of its income in Pennsylvania or Germany? Why?

The ROI calculation will indicate:

Sullivan Enterprises had a sales margin of 5%, sales of $4,000,000, and invested capital of $5,000,000. The company's ROI was:

Which of the following performance measures is(are) used to evaluate the general financial success or failure of investment centers?

Sunrise Corporation has a return on investment of 15%. A Sunrise division, which currently has a 13% ROI and $750,000 of residual income, is contemplating a massive new investment that will (1) reduce divisional ROI and (2) produce $120,000 of residual income. If Sunrise strives for goal congruence, the investment:

New England Corporation has two divisions, Providence and Buffalo, and evaluates management on the basis of return on investment. Providence currently makes a part that it sells to both Buffalo and outsiders. Selected data follow. Selling price to Buffalo \ 25 Variable cost 18 Fixed costs 80,000 Providence is seeking an increase in its selling price to $28 per unit because of rising costs. Buffalo can obtain comparable units from an outside supplier for $26; however, if Buffalo uses the supplier, Providence will have idle capacity because of an inability to increase sales to outsiders. From the perspective of New England Corporation:

Signature Scents has two divisions: the Cologne Division and the Bottle Division. The Bottle Division produces containers that can be used by the Cologne Division. The Bottle Division's variable manufacturing cost is $2, shipping cost is $0.10, and the external sales price is $3. No shipping costs are incurred on sales to the Cologne Division, and the Cologne Division can purchase similar containers in the external market for $2.60. Assume the Bottle Division has no excess capacity and could sell everything it produced externally. Using the general rule, the transfer price from the Bottle Division to the Cologne Division would be:

ROI is most appropriately used to evaluate the performance of:

The following information pertains to Bishop Concrete: Sales revenue \ 1,500,000 Gross margin 600,000 Income 90,000 Invested capital 450,000 The company's imputed interest rate is 8%. The ROI is:

McKenna's Florida Division is currently purchasing a part from an outside supplier. The company's Alabama Division, which has excess capacity, makes and sells this part for external customers at a variable cost of $22 and a selling price of $34. If Alabama begins sales to Florida, it (1) will use the general transfer-pricing rule and (2) will be able to reduce variable cost on internal transfers by $4. If sales to outsiders will not be affected, Alabama would establish a transfer price of:

Vision, Inc. reported a return on investment of 12%, a capital turnover of 5, and income of $180,000. On the basis of this information, the company's invested capital was:

All of the following actions are likely to increase ROI except:

Consider the following data of Twill Corporation's Eastern Division: Sales revenue \ 18,750,000 Capital turnover ? Average invested capital ? Sales margin 4\% Income ? Return on investment 15\% Residual income ? Twisted's imputed interest rate 12\% Required: A. Calculate Eastern's capital turnover. B. Calculate Eastern's average invested capital. C. Calculate Eastern's income. D. Calculate residual income.

Sonoma Corporation is a multi-divisional company whose managers have been delegated full profit responsibility and complete autonomy to accept or reject transfers from other divisions. Division X produces 2,000 units of a subassembly that has a ready market. One of these subassemblies is currently used by Division Y for each final product manufactured, the latter of which is sold to outsiders for $1,600. Y's sales during the current period amounted to 2,000 completed units. Division X charges Division Y the $1,100 market price for the subassembly; Division Y has additional variable costs of $600 per unit. Variable costs for Division X are $850 per unit. The manager of Division Y feels that X should transfer the subassembly at a lower price because Y is currently unable to make a profit. Required: A. Calculate the contribution margins (total dollars and per unit) of Divisions X and Y, as well as the company as a whole, if transfers are made at market price. B. Assume that conditions have changed and X can sell only 1,000 units in the market at $900 per unit. From the company's perspective, should X transfer all 2,000 units to Y or sell 1,000 in the market and transfer the remainder? Note: Y's sales would decrease to 1,000 units if the latter alternative is pursued.

Signature Scents has two divisions: the Cologne Division and the Bottle Division. The Bottle Division produces containers that can be used by the Cologne Division. The Bottle Division's variable manufacturing cost is $2, shipping cost is $0.10, and the external sales price is $3. No shipping costs are incurred on sales to the Cologne Division, and the Cologne Division can purchase similar containers in the external market for $2.60. The Bottle Division has sufficient capacity to meet all external market demands in addition to meeting the demands of the Cologne Division. Using the general rule, the transfer price from the Bottle Division to the Cologne Division would be: