24/04/2024

REVISION
LECTURE 13

Topics to be covered in final exam

• Inventory management
• Capital budgeting
• Management control system and transfer pricing
• Performance measurement

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Inventory management

• Management of inventory costs

• EOQ model
• Formula
• Assumptions
• Reorder point
• Just in time
• Features
• Costs and benefits of JIT
• MRP
• ERP

Capital budgeting

• Stages in capital budgeting

• Capital budgeting methods
• NPV
• IRR (calculator, interpolation)
• Payback/Discounted payback
• AARR
• Advantages and disadvantages of each method
• CFs, timing of CFs, tax
• Decision

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Management control system and transfer

pricing

• Management control system

• Organisation structure and decentralization
• Costs & benefits of decentralization
• Transfer pricing
• Market based transfer prices
• Cost based transfer prices
• Hybrid transfer prices
• Comparison among different transfer prices
• Minimum transfer price

Performance measurement

• Accounting based performance measures

• ROI
• RI
• EVA
• ROS
• Non financial measures – balanced scorecard
• Advantages and disadvantages
• Choice among different methods

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Final exam format – 120 minutes

• MCQ: 20 questions (20 marks)

• Problem 1: Inventory management (20 marks)
• Problem 2: Capital budgeting (20 marks)
• Problem 3: Performance measurement (20 marks)
• Problem 4: Management control and transfer pricing (20 marks)

Practice questions- Inventory management

Turfpro Company produces lawn mowers and purchases 4,500 units of a rtor blade
part each year at a cost of $30 per unit. Turfpro requires a 15% annual rate of return
on investment. In addition, the relevant carrying cost (for insurance, materials
handling, breakage, etc.) is $3 per unit per year. The relevant ordering cost per
purchase order is $75.
1. Calculate Turfpro’s EOQ for the rotor blade part.
2. Calculate Turfpro’s annual relevant ordering costs for the EOQ calculated in
requirement 1.
3. Calculate Turfpro’s annual relevant carrying costs for the EOQ calculated in
requirement 1.
4. Assume that demand is uniform throughout the year and known with certainty so
there is no need for safety stocks. The purchase-order lead time is half a month.
Calculate Turfpro’s reorder point for the rotor blade part.

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Practice questions – Capital budgeting

City Hospital, a nonprofit organization, estimates that it can save $28,000 a year
in cash operating costs for the next 10 years if it buys a special-purpose eye-
testing machine at a cost of $110,000. No terminal disposal value is expected. City
Hospital’s required rate of return is 14%. Assume all cash flows occur at year-end
except for initial investment amounts. City Hospital uses straight-line
depreciation.
1. Calculate the following for the special-purpose eye-testing machine:
• Net present value
• Payback period
• Internal rate of return
• Accrual accounting rate of return based on net initial investment
• Accrual accounting rate of return based on average investment
2. What other factors should City Hospital consider in deciding whether to
purchase the special-purpose eye-testing machine?

Practice questions – Transfer pricing

• Cran Health Products is a cranberry cooperative that operates two divisions, a harvesting division
and a processing division. Currently, all of harvesting’s output is converted into cranberry juice by
the processing division, and the juice is sold to large beverage companies that produce cranberry
juice blends. The processing division has a yield of 500 gallons of juice per 1,000 pounds of
cranberries. Cost and market price data for the two divisions are as follows:

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Practice questions – Transfer pricing

1. Compute Cran Health’s operating income from harvesting 480,000 pounds of

cranberries during June 2017 and processing them into juice.
2. Cran Health rewards its division managers with a bonus equal to 6% of operating
income. Compute the bonus earned by each division manager in June 2017 for
each of the following transfer-pricing methods:
• 225% of full cost
• Market price
3. Which transfer-pricing method will each division manager prefer? How might
Cran Health resolve any conflicts that may arise on the issue of transfer pricing?

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Practice questions – Performance

measurement

• Hamilton Corp. is a reinsurance and financial

services company. Hamilton strongly believes
in evaluating the performance of its stand-
alone divisions using financial metrics such as
ROI and residual income
• For the purposes of divisional performance
evaluation, Hamilton defines investment as
total assets and income as operating income
(that is, income before interest and taxes).
The firm pays a flat rate of 25% in taxes on its
income.

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Practice questions – Performance

measurement
1. What was the net income after taxes of the property/casualty division?
2. What was the division’s ROI for the year?
3. Based on Hamilton’s required rate of return of 8%, what was the
property/casualty division’s residual income for 2017?
4. Hamilton’s CFO has heard about EVA and is curious about whether it might be
a better measure to use for evaluating division managers. Hamilton’s four
divisions have similar risk characteristics. Hamilton’s debt trades at book
value while its equity has a market value approximately 150% that of its book
value. The company’s cost of equity capital is 10%. Calculate each of the
following components of EVA for the property/casualty division, as well as
the final EVA figure:
• Net operating profit after taxes
• Weighted-average cost of capital
• Investment, as measured for EVA calculations

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