PROBLEM 1 - Calculating Unknowns, Predicting Relationship among Return on Investment,

Residual Income, Hurdle Rates

The following is partial information for OCL Company’s most recent year of operation. It manufactures
lawn mowers and categorizes its operations into two divisions: Bermuda and Midiron.

Bermuda Midiron
Division Division
Sales revenue ? 600,000
Average invested assets 2,500,000 ?
Net operating income 160,000 150,000
Profit margin 20% ?
Investment Turnover ? .16
Return on investment ? ?
Residual income 40,000 (30,000)

Requirement:
1. Without making any calculations, determine whether each division’s return on investment is
above or below OCL’s hurdle rate. How can you tell?
2. Determine the missing amounts in the preceding table.
3. What is OCL’s hurdle rate?
4. Suppose OCL Company has the opportunity to invest additional assets to help expand the
company’s market share. The expansion would require an average investment of $2,800,000 and
would generate $140,000 in additional income. From OCL’s perspective, is this a viable
investment? Why or why not?
5. Suppose the two divisions would equally share the investment and profits from the expansion
project. If return on investment is used to evaluate performance, what will each division manager
think about the proposed project?
6. In requirement 5, will either manager’s preference change if residual income is used to measure
division performance? Explain your answer.
PROBLEM 2 – Evaluating Managerial Performance, Proposed Project Impact on Return on
Investment, Residual Income
LBY Company has two divisions: A and B. The company has a hurdle rate of 8 percent. Selected
operating data for the three divisions are as follows:

Division A Division B
Sales revenue 1,255,000 920,000
Cost of goods sold 776,000 675,00
Miscellaneous operating expenses 64,000 52,000
Interest and taxes 48,000 41,000
Average invested assets 8,300,000 1,930,000

LBY is considering an expansion project in the upcoming year that will cost $5 million and return
$450,000 per year. The project would be implemented by only one of the three divisions.
Required:
1. Compute the ROI for each division.
2. Compute the residual income for each division.
3. Rank the divisions according to the ROI and residual income of each.
4. Compute the return on the proposed expansion project. Is this an acceptable project?
5. Without any additional calculations, state whether the proposed project would increase or
decrease each division’s ROI.

PROBLEM 3 – Calculating Return on Investment, Residual Income, Determining Effect of

Changes in Sales, Expenses, Invested Assets, Hurdle Rate on Each

Froy Company has the following information available for the past year:

River Division Streamer

Division
Sales revenue $ 14 168,000
COGS and operating expenses 10 120,000
Net operating income 3 36,000
Average invested assets 6 72,000
The company’s hurdle rate is 6%

Required:
1. For each division, calculate:
a) return on investment (ROI); and,
b) residual income
2. Rank the divisions according to the ROI and residual income of each.
3. Recalculate ROI and residual income for each division for each independent situation that
follows:
a. Operating income increases by 10 percent.
b. Operating income decreases by 10 percent.
c. The company invests $250,000 in each division, an amount that generates $100,000
additional income per division.
d. Froy changes its hurdle rate to 10 percent.

PROBLEM 4 – Compute the Return on Investment (ROI)

Leticia Services Company, a division of a major oil company, provides various services to the operators
of the North Slope oil field in Alaska. Data concerning the most recent year appear below:

Sales 7,500,000
NOI 600,000
Average operating assets 5,000,000
Required:
1. Compute the margin
2. Compute the turnover
3. Compute the return on investment

PROBLEM 5 – Transfer Pricing

Felychee, Inc., is a nursery products firm. It has three divisions that grow and sell plants: the Western
Division, the Southern Division, and the Canadian Division. Recently, the Southern Division of Felychee
acquired a plastics factory that manufactures green plastic pots. These pots can be sold both externally
and internally. Company policy permits each manager to decide whether to buy or sell internally. Each
divisional manager is evaluated on the basis of return on investment and EVA.

The Western Division had bought its plastic pots in lots of 100 from a variety of vendors. The average
price paid was $75 per box of 100 pots. However, the acquisition made Ofeleth Labay, manager of the
Western Division, wonder whether a more favorable price could be arranged. She decided to approach
Leticia Cruzado, manager of the Southern Division, to see if he wanted to offer a better price for an
internal transfer. She suggested a transfer of 3,500 boxes at $70 per box.

Leticia gathered the following information regarding the cost of a box of 100 pots:

Direct materials $35

Direct labor 8
Variable overhead 10
Fixed overhead (based on 200,000/20,000 boxes) 10
Total unit cost 63

Selling price $75

Production capacity 20,000 boxes

Required:
1. Suppose that the plastics factory is producing at capacity and can sell all that it produces to
outside customers. How should Leticia respond to Ofeleth’s request for a lower transfer price?
2. Now assume that the plastics factory is currently selling 16,000 boxes. What are the minimum
and maximum transfer prices? Should Leticia consider the transfer at $70 per box?
3. Suppose that Felychee’s policy is that all transfer prices be set at full cost plus 20 percent. Would
the transfer take place? Why or why not?

PROBLEM 6 – Full cost-plus pricing and negotiation

Cruzado Inc. has two divisions: Auxiliary Components and Audio Systems. Divisional managers are
encouraged to maximize ROI and EVA. Managers are essentially free to determine whether goods will be
transferred internally and what the internal transfer prices will be.
Headquarters has directed that all internal prices be expressed on a full cost-plus basis. The markup in the
full cost pricing arrangement, however, is left to the discretion of the divisional managers. Recently, the
two divisional managers met to discuss a pricing agreement for a subwoofer that would be sold with a
personal computer system. Production of the subwoofers is at capacity.

Subwoofers can be sold for $31 to outside customers. The Audio Systems Division can also buy the
subwoofer from external sources for the same price; however, the manager of this division is hoping to
obtain a price concession by buying internally.

The full cost of manufacturing the subwoofer is $20. If the manager of the Auxiliary Components
Division sells the subwoofer internally, $5 of
selling and distribution costs can be avoided. The volume of business would be 250,000 units per year,
which is well within the capacity of the producing division.

After some discussion, the two managers agreed on a full cost-plus pricing scheme that would be
reviewed annually. Any increase in the outside selling price would be added to the transfer price by
simply increasing the markup by an appropriate amount. Any major changes in the factors that led to the
agreement could initiate a new round of negotiation. Otherwise, the full cost-plus arrangement would
continue in force for subsequent years.

Required:
1. Calculate the minimum and maximum transfer prices.
2. Assume that the transfer price agreed on between the two managers is halfway between the
minimum and maximum transfer prices. Calculate this transfer price. What markup over full
cost is implied by this transfer price?
3. Refer to Requirement 2. Assume that in the following year, the outside price of subwoofers
increases to $32. What is the new full cost-plus transfer price?

PROBLEM 7 – Transfer Pricing

Quali Products, Inc., has a Valve Division that manufactures and sells a standard valve:

Capacity in units 100,000

Selling price to outside customers 30
Variable costs per unit 16
Fixed costs per unit (based on capacity) 9

The company has a Pump Division that could use this valve in one of its pumps. The Pump Division is
currently purchasing 10,000 valves per year from an overseas supplier at a cost of $29 per valve.

Required:
1. Assume that the Valve Division has enough idle capacity to handle all of the Pump Division’s
needs. What is the range of acceptable transfer prices, if any, for the transfer between the two
divisions?
 2. Assume that the Valve Division is selling all of the valves it can produce to outside customers.
What is the range of acceptable transfer prices, if any, for the transfer between the two
divisions?
3. Assume again that the Valve Division is selling all of the valves it can produce to outside
customers. Also assume that $3 in variable expenses can be avoided on transfers within the
company, due to reduced selling costs. What is the range of acceptable transfer prices, if any,
for the transfer between the two divisions?

PROBLEM 8 – Transfer Pricing Basics

CPA Company’s Audio Division produces a speaker that is used by manufacturers of various audio
products. Sales and cost data on the speaker follow:

Selling price per unit on the intermediate market 60

Variable costs per unit 42
Fixed costs per unit (based on capacity) 8
Capacity in units 25,000

CPA Company has a Hi-Fi Division that could use this speaker in one of its products. The Hi-Fi Division
will need 5,000 speakers per year. It has received a quote of $57 per speaker from another manufacturer.
CPA Company evaluates division managers on the basis of divisional profits.

Required:
1. Assume the Audio Division sells only 20,000 speakers per year to outside customers.
a) From the standpoint of the Audio Division, what is the lowest acceptable transfer price
for speakers sold to the Hi-Fi Division?
b) From the standpoint of the Hi-Fi Division, what is the highest acceptable transfer price
for speakers acquired from the Audio Division?
c) What is the range of acceptable transfer prices (if any) between the two divisions? If left
free to negotiate without interference, would you expect the division managers to
voluntarily agree to the transfer of 5,000 speakers from the Audio Division to the Hi-Fi
Division? Why or why not?
d) From the standpoint of the entire company, should the transfer take place? Why or why
not?
2. Assume the Audio Division is selling 25,000 speakers per year to outside customers.
a) From the standpoint of the Audio Division, what is the lowest acceptable transfer price
for speakers sold to the Hi-Fi Division?
b) From the standpoint of the Hi-Fi Division, what is the highest acceptable transfer price
for speakers acquired from the Audio Division?
c) What is the range of acceptable transfer prices (if any) between the two divisions? If left
free to negotiate without interference, would you expect the division managers to
voluntarily agree to the transfer of 5,000 speakers from the Audio Division to the Hi-Fi
Division? Why or why not?
d) From the standpoint of the entire company, should the transfer take place? Why or why
not?
PROBLEM 9 – Measures of Internal Business Process Performance
Management of Graduate Company would like to reduce the amount of time between when a customer
places an order and when the order is shipped. For the first quarter of operations during the current year
the following data were reported:

Inspection time .3 days

Wait time 14 days
Process time 2.7 days
Move time 1 day
Queue time 5 days

Required:
1. Compute the throughput time.
2. Compute the manufacturing cycle efficiency (MCE) for the quarter.
3. What percentage of the throughput time was spent in non–value-added activities?
4. Compute the delivery cycle time.

Problem 7: International Transfer Pricing

QPR Co. has two divisions located in Korea and USA. The one located in Korea manufactures a
product used in USA. Assuming the tax rate in Korea and USA is 30% and 45% respectively,
compute of the following requirements given the incurred costs.
Variable cost to manufacture 18
Fixed cost to manufacture 4
Shipping cost from Korea to USA 1.50
Korea division can sell its product for 30 per unit locally while the USA division can purchase the
product for 35 each.
Requirements:
1. What is the maximum and minimum transfer price?
2. What internal transfer price shall take place, variable cost or market price? Explain
3. What is the effect of the best alternative to the overall income of the company, if units to
be transferred are 5,000?