Decision Making

Dropping a Segment
Genco Fashions uses its available space for three product lines. Following is the income
statement for a recent month, and Gencos managers expect these results to continue in the
foreseeable future.

Sales
Variable costs
---Contribution margin
Fixed costs:
Direct- all avoidable
Indirect (common),
allocated on sales
----Income (loss)

Clothing
---------45,000
25,000
----------

Shoes
-------40,000
18,000
---------

Jewelry
Total
-------------------15,000
1, 00,000
11,000
54,000
-----------------

20,000

22,000

4,000

46,000

(4,000)

(3,400)

(1,500)

(8900)

(9,450)
----------

(8,400)
---------

(3,150)

(21,000)

6,550

10,200

(650)

---------

--------16,100

Should the store drop the jewelry line because it shows a loss?
a. The space released by closing the jewelry line can be rented for Rs.400 per month and
the company would save Rs.1,000 on common indirect costs.
b. The company can operate a music department in the space now occupied by Jewelry.
The music department will generate a revenue of Rs.20,000, incur variable costs of
Rs.8,000 and direct fixed costs of Rs.2,700.

Make or Buy a Part assuming Idle Capacity

A company manufactures 10,000 units of a product X in 50 batches. The number of batches is
the cost driver of material handling and set up activities. Total material handling and set up costs
equal fixed cost of Rs. 5,000 plus a variable cost of Rs. 300 per batch. Other costs are detailed
below:
1

Direct material
Direct labour
Variable manufacturing overhead (power
& utilities)
Semi-variable manufacturing overhead
(material handling & set up)
Fixed manufacturing overhead
(rent, insurance & administration)
Total manufacturing cost

Per unit
Rs.
8.00
1.00

Total
Rs.
80,000
10,000

4.00

40,000

2.00

20,000

3.00
-----18.00
--------

30,000
-----------1,80,000
------------

Another manufacturer offers to sell 10,000 units of the product at Rs. 16 per unit. Should the
product be made or bought?
Make or Buy Decision When Capacity has Alternative Use
In the above example, assume that it is possible to use the capacity to manufacture 5,000 units of
another part Y with the following revenues and costs.
Rs.
Incremental revenue

Rs.
80,000

Incremental costs
Direct material
Direct labour
Variable overhead (power, utilities)
Material handling & set up overheads
Total incremental costs
Incremental operating income

30,000
5,000
15,000
5,000
---------55,000
----------25,000
-----------

Because of capacity constraints, the company can make either X or Y but not both. It has three
alternatives to choose from:
2

(1) make X and do not make Y

(2) buy X and do not make Y
(3) buy X and make Y
Which alternative should the company use?
Product-Mix Decisions under Capacity Constraint
A company assembles two engines X and Y. The following information is given:
Engine X

Engine Y

Rs.
Selling Price
Variable Cost per unit
Contribution per unit
Contribution margin percent

Rs.

32,000
22,400
9,600
30

40,000
25,000
15,000
37.5

Total machine hours available daily are 600. It takes 2 machine hours to produce 1 unit of engine
X and 5 machine hours to produce one unit of engine Y.

Evaluation of Investment Centers

1. The following data relates to division X of a company.
Average selling price
Average variable cost
Total fixed costs
Investment

Rs.20
8
Rs. 4,00,000
Rs. 10,00,000

Required:
Answer each of the following questions independently.
a.
b.
c.
d.

How many units must X sell to earn a 20% ROI?

If the division sells 60,000 units, what will ROI be?
The minimum desired ROI is 15%. If the division sells 60,000 units, what is RI?
The manager desires a 25% ROI and wishes to sell 50,000 units. What price must she
charge?
e. The minimum desired ROI is 20% and RI is Rs.60, 000. What are sales in units?

2. Megatronics Corporation, a massive retailer of electronic products, is organized in four

separate divisions. The four divisional managers are evaluated at year-end, and bonuses are
awarded based on ROI. Last year, the company as a whole produced a 13 percent return on its
investment.
During the past week, management of the companys Western Division was approached about the
possibility of buying a competitor that had decided to redirect its retail activities. The data that
follow relate to recent performance of the Western Division and the competitor:

Sales
Variable costs (percent of sales)
Fixed costs
Invested capital

Western Division

Competitor

Rs.42 cr.
70
Rs.10.75 cr.
Rs. 9.25 cr.

Rs.26 cr.
65
Rs.8.35 cr.
Rs.3.125 cr

Management has determined that in order to upgrade the competitor to Megatronics standards,
an additional Rs.1.875 cr. of invested capital be needed.
Required:
a. Compute the current ROI of the Western Division and the divisions ROI if the competitor is
acquired.
b. What is the likely reaction of divisional management toward the acquisition? Why?
c. What is the likely reaction of Megatronics corporate management toward the acquisition?
Why?
d. Would the division be better off if it didnt upgrade the competitor to Megatronics standards?
Show computations to support your answer.
e. Assume that Megatronics uses residual income to evaluate performance and desires a 12
percent minimum return on invested capital. Compute the current residual income of the
Western Division and the divisions residual income if the competitor is acquired. Will
divisional management be likely to change its attitude toward the acquisition? Why?