Tutorial 3 suggested answers Page 1 of 7

Question 1

Increasing sales activity can be related to increased number of new accounts; thus, many brokerages
set objectives for its brokers to make a set number of 'cold calls' to solicit investments from potential
clients. However, a large number of small accounts probably do not have the same impact on sales
as a few large accounts.

The brokerage firm must be careful not to divert its employees' energies so much to finding new
accounts that research, analysis, and service for existing accounts are neglected. Service firms have
found that it is much more profitable to retain existing customers than to find new customers.
Therefore, customer retention has become a major objective, and performance is measured on
activities that are believed to aid in retaining profitable customers. These measures include how
quickly phones are picked up, how quickly inquiries are answered, accessibility of data bases, and so
on.

Question2

1. Bloomington Honda
Parts and Vehicles
Service sales

$ $
Sales 600,000 2,400,000
Cost of sales (1,920,000)
Parts and Service materials (180,000) -
Parts and Service labour (240,000) -
Sales commissions 0 (48,000)
Subtotal (420,000) (1,968,000)
Mark-up on "variable" material and labour* 180,000 432,000
Parts and service overhead (60,000) -
Advertising 0 (120,000)
Sales salaries 0 (60,000)
General dealership overhead** (120,000) (80,000)
Net income 0 172,000

*Roughly equivalent to contribution margin.

** $180,000 - $60,000 = $120,000. Following the president’s view that the parts and service
operation exists only to recover costs, this amount is allocated to Parts and Service so that the
income (after allocated overhead) is exactly zero. This approach also implies that the remaining
$80,000 of general dealership overhead is allocated to Vehicles sales .

These are suggested solutions. Students are advised to answer in their own words to avoid high originality %.
 Tutorial 3 suggested answers Page 2 of 7

Parts and Vehicles

2. Service ($) sales ($) Total ($)
Markup on "variable" material and labour 180,000 432,000 612,000
Parts and service overhead (60,000) 0
Advertising 0 (120,000)
Sales salaries 0 (60,000)
Direct allocation of general overhead (24,000) (120,000)
Total expenses directly charged to departments (84,000) (300,000) (384,000)
Departmental contribution to net income 96,000 132,000 228,000
General overhead not allocable 56,000
Net income of the dealership as a whole 172,000

The operating statement by departments would be the same as (1) through 'mark-up on variable
material and labour.' At that point general overhead should be allocated to the two departments
insofar as such allocations can be accomplished without reliance on arbitrary assumptions. The
remaining $56,000 of general overhead should not be allocated at all. The bottom of the income
statement could appear as follows:

Question 3

1. Turnover of capital = Sales ÷ Invested capital

= $120,000 ÷ $60,000
= 200% or 2.0 times
2. Return on sales = $6,000 ÷ $120,000 = 0.05

3. Return on Investment (ROI) = $6,000 ÷ $60,000 = 10%

or = 2.0 × 5.0% = 10%

Question 4

The basic equation: ROI = Return on Sales × Capital turnover

A: 7% x 3 = 21%
B: 18% ÷ 3% = 6
C: 20% ÷ 4 = 5%

These are suggested solutions. Students are advised to answer in their own words to avoid high originality %.
 Tutorial 3 suggested answers Page 3 of 7

Question 5

1. The filled-in blanks are underscored:

Division
X Y Z
Invested capital $1,000,000 $1,300,000 $1,250,000
Income $100,000 $182,000 $162,500
Revenue, $1,250,000 × 3 $2,500,000 $3,640,000 $3,750,000
Return on sales,
Income ÷ Sales 4.0% 5.0% 4.33%
Capital turnover,
Sales ÷ Invested capital 2.5 2.8 3.0
Return on invested capital,
Income ÷ Invested capital 10% 14% 13%

2. Division
X Y Z
Income $100,000 $182,000 $162,500
Capital charge 120,000 156,000 150,000
Economic profit ($20,000) $26,000 $12,500

3. If the criterion for judging relative performance is ROI, Division Y is best for this period. If the
criterion is economic profit, then both Division Y and Division Z are producing positive
economic profit, with Division Y producing more. Other factors deserving attention include
the relative risks faced by each division and the short-run versus long-run implications of
current performance.

Question 6

2018: Adjusted operating profit after tax ($71,460 - $10,853) $60,607

Capital charge ( 0.094 × $1,687,082) 158,586
EVA ($97,979)

2017: Adjusted operating profit after tax ($52,190 - $30,424) $21,766

Capital charge ( 0.099 × $1,652,321) 163,580
EVA ($141,814)

Briggs & Stratton ’s overall performance improved, with EVA increasing from a negative
$141,813,779 to a negative $97,978,708. Part of this was due to an increase in the adjusted after-tax
operating profit, and part was due to the decreased capital charge.

These are suggested solutions. Students are advised to answer in their own words to avoid high originality %.
 Tutorial 3 suggested answers Page 4 of 7

Question 7

Laurel Hardy
Assets $2,000,000 $2,000,000
Liabilities 1,200,000 0
Stockholders’ equity 800,000 2,000,000
Income before interest 400,000 400,000
10% interest 120,000 0
Net income $280,000 $400,000
Rate of return on:
Assets 14% 20%
Stockholders equity 35% * 20%
*$280,000 ÷ $800,000 = 35%

The gross rate of return on assets (before considering interest expense) is 20%. For Hardy , with no
debt in the capital structure, the return on assets and return on stockholders’ equity are the same.
For Laurel , with a large amount of debt in the capital structure, there is a large impact of debt on
the net return on assets (after interest expense) and return on stockholders' equity.

Laurel Company in effect has paid 10% for the use of $1,200,000, which in turn has earned a gross
return of 20%, yielding a lower net return on assets of 14% and a much higher return on equity of
35%. When the return on assets is higher than the cost of debt as in this example, a larger
proportion of debt in the capital structure benefits stockholders. However, when the gross rate of
return on assets is lower than the cost of debt, a larger proportion of debt hurts stockholders.

Top management has two major functions: operating and financing. Measures of operational
performance (how assets are employed) should not be combined with measures that reflect the
effects of financing decisions (how funds for investing are obtained).

Question 8

1. (b) (a)
Sell to Outsiders
Process Further at Transfer Point
FINISHING ASSEMBLY
DIVISION Overall DIVISION Overall
Performance Performance Performance Performance

Selling Price $85.00 $85.00 $ - $63.00

Variable costs:
Assembly Division $50.00 $50.00
Finishing Division 28.00 -
Total variable costs $78.00 $78.00 $50.00 $50.00
Contribution to net income $7.00 $7.00 $ - $13.00

These are suggested solutions. Students are advised to answer in their own words to avoid high originality %.
 Tutorial 3 suggested answers Page 5 of 7

2.
If the transfer price is based on variable cost, the manager of the finishing division would want the
product processed further. But this would hurt overall company performance. The essential
question is whether the finishing division should offer the final product in the market at all. The
incremental revenue of $22.00 is less than the incremental cost of $28.00 incurred to sand and finish
the chair.

Question 9

1. If wheels were available for $14.00 each in the market, Dayton would not be willing to pay
more than $14.00 to Toledo. If wheels could not be purchased in the market, the maximum
price would be $20.00, computed as follows:

Sales price $170

Variable costs (except for wheels) $130
Contribution available for wheels and to cover fixed costs and profit $40
The $40.00 must pay for 2 wheels, so the most that can be paid per wheel is $40.00 ÷ 2 =
$20.00. The manager of the Dayton Division would likely not pay the entire amount of $20.00
per wheel, because that would leave no contribution to fixed costs plus profit. However, any
price less than $20.00 would produce a positive contribution margin and therefore be better
than not producing the bicycles.

2.
Because there is excess capacity, any transfer price above the variable cost of $10.00 would
result in a positive contribution margin. No price below $10.00 would be acceptable. If there
were no excess capacity, the minimum transfer price would be the market price of $14.00.
Why? Because the Toledo Division would have to forgo $14.00 of revenue from an external
sale in order to transfer a wheel internally.

Question 10

1. Both the shocks and struts division and the company as a whole will benefit if the $42.00 price is
met. If the shocks and struts division does not sell to the automotive division, 75% of the strut
assembly volume will disappear, and gross margin will fall to $375,000 as follows:

Sales, 250,000 at $57.00 $14,250,000

Variable costs, at $37.50 $9,375,000
Fixed costs 4,500,000
Total costs 13,875,000
Gross margin $375,000

If the $42.00 price is met, the shocks and struts division will show a gross margin of $3,750,000 as
follows:

To To

These are suggested solutions. Students are advised to answer in their own words to avoid high originality %.
 Tutorial 3 suggested answers Page 6 of 7

Automotive
division Outsiders Total
Sales:
750,000 at $42.00 $31,500,000
250,000 at $57.00 $14,250,000 $45,750,000
Variable costs $28,125,000 $9,375,000 37,500,000
Fixed costs 3,375,000 1,125,000 4,500,000
Total costs $31,500,000 $10,500,000 $42,000,000
Gross margin $0 $3,750,000 $3,750,000

The rejection of intracompany business will slash margins by $3,750,000 -

$375,000 = $3,375,000. Alternatively, the acceptance of intracompany
business will result in a contribution margin of $4.50 per strut assembly ($42.00
less $37.50 variable costs) or $4.50 × 750,000 = $3,375,000 which otherwise
will be forgone.

2. Yes, the division should reject intracompany sales and concentrate on outside sales since the
gross margin would be $4,500,000, whereas the gross margin if automotive division business
were accepted would be $3,750,000. The gross margin would increase by $750,000 as follows:

Sales, 1,000,000 at $54.00 $54,000,000

Variable costs, at $42.00 $42,000,000
Fixed costs 7,500,000
Total costs 49,500,000
Gross margin (new proposal) $4,500,000
Gross margin (accepting intracompany business) $3,750,000
Difference $750,000

Question 11

The minimum transfer price is $23.00. Any price below $23.00 would cause the Fabricating Division
to lose profit. In fact, the minimum transfer price could be slightly above $23.00 if the Fabricating
Division, despite its current situation with excess capacity, would limit its future flexibility by agreeing
to the production and transfer.

The maximum price is $39.00, the price at which the Lighting Division could buy the lamp shade on
the market. It might be slightly less than $39.00 if the Lighting Division can save some transportation
or handling costs by buying internally, or if it can be more confident in the quality when purchasing
internally.

These are suggested solutions. Students are advised to answer in their own words to avoid high originality %.
 Tutorial 3 suggested answers Page 7 of 7

Question 12

(a) The B divisional manager will not be happy and may oppose the transfer. Currently, the
division sells all the units it produces at £23 each. The transfers to A are at a transfer
price of £22 per unit, so B will suffer a £1 drop in sales revenue and profit on each unit
that it sends to A.
(b)
Although A is receiving a £1 lower price on each unit purchased from B compared to
outside suppliers, the £22 transfer price would probably be deemed too high. as A will
lose £2 on each noodle produced and sold.

Sales revenue $42

Less: Variable manufacturing costs $22
Transfer price paid to B 22 44
Profit (loss) ($2)

(c)
Although top management wants to introduce the noodle, it should not lower the price
to make the transfer attractive to A since FTL uses a responsibility accounting system,
awarding bonuses based on divisional performance. Top management’s intervention
and price-lowering decision would undermine the authority and autonomy of B’s and
A’s divisional managers. Therefore, it is better that the two divisional managers should
negotiate a mutually agreeable price.

(d)
FTL would benefit more if it sells the sambal powder externally and does not use the
sambal powder to produce the noodle.

Produce
Produce
sambal
sambal
powder;
powder; sell
transfer; sell
externally
noodle

Sales revenue $23 $42

Less: variable cost:
$15 15
£15 + £22 37
Contribution margin $8 $5

These are suggested solutions. Students are advised to answer in their own words to avoid high originality %.