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Chapter 24: 20RQ (page 1324)
What is the biggest disadvantage of using ROI to evaluate investment centers?
The absence of consideration for a cash as a measure is one of the drawbacks of ROI.
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Explain the difference between a centralized company and a decentralized company.
The Harris Company is decentralized, and divisions are considered investment centers. Harris has one division that manufactures oak dining room chairs with upholstered seat cushions. The Chair Division cuts, assembles, and finishes the oak chairs and then purchases and attaches the seat cushions. The Chair Division currently purchases the cushions for \(22 from an outside vendor. The Cushion Division manufactures upholstered seat cushions that are sold to customers outside the company. The Chair Division currently sells 800 chairs per quarter, and the Cushion Division is operating at capacity, which is 800 cushions per quarter. The two divisions report the following information:
Chair Division Cushion Division
Sales Price per Chair \) 85 Sales Price per Cushion \( 32
Variable Cost (other than cushion) 42 Variable Cost per Cushion 13
Variable Cost (cushion) 22
Contribution Margin per Chair \) 21 Contribution Margin per Cushion $ 19
Requirements
1. Determine the total contribution margin for Harris Company for the quarter.
2. Assume the Chair Division purchases the 800 cushions needed from the Cushion Division at its current sales price. What is the total contribution margin for each division and the company?
3. Assume the Chair Division purchases the 800 cushions needed from the Cushion Division at its current variable cost. What is the total contribution margin for each division and the company?
4. Review your answers for Requirements 1, 2, and 3. What is the best option for Harris Company?
5. Assume the Cushion Division has capacity of 1,600 cushions per quarter and can continue to supply its outside customers with 800 cushions per quarter and also supply the Chair Division with 800 cushions per quarter. What transfer price should Harris Company set? Explain your reasoning. Using the transfer price you determined, calculate the total contribution margin for the quarter.
Consider the following condensed financial statements of Forever Free, Inc. The company’s target rate of return is 40%.
Forever Free, Inc | |
Income Statement | |
For the year ended December 31, 2018 | |
Net Sales revenue | \( 3,500,000 |
Cost of Goods Sold | 2,200,000 |
Gross Profit | 1,300,000 |
Operating Expenses | 950,000 |
Operating Income | 350,000 |
Other income and (expenses) | |
Interest Expense | (27,000) |
Income before income tax expense | 323,000 |
Income tax expense | 113,050 |
Net Income | \) 209,950 |
Forever Free, Inc | ||
Income Statement | ||
For the year ended December 31, 2018 | ||
2018 | 2017 | |
Assets | ||
Cash | \( 64,000 | \) 52,000 |
Accounts Receivable | 49,200 | 17,800 |
Supplies | 1,000 | 400 |
Property, Plant, and Equipment, net | 331,800 | 229,800 |
Patents, net | 135,000 | 119,000 |
Total Assets | \( 581,000 | \) 419,000 |
Liabilities and Stockholders’ Equity | ||
Accounts Payable | \( 17,000 | \) 19,000 |
Short-term Notes Payable | 136,000 | 42,000 |
Long-term Notes Payable | 184,000 | 114,500 |
Common Stock, no Par | 232,000 | 242,000 |
Retained Earnings | 12,000 | 1,500 |
Total Liabilities and Stockholders’ Equity | \( 581,000 | \) 419,000 |
Requirements
1. Calculate the company’s ROI. Round all of your answers to four decimal places.
2. Calculate the company’s profit margin ratio. Interpret your results.
3. Calculate the company’s asset turnover ratio. Interpret your results.
4. Use the expanded ROI formula to confirm your results from Requirement 1. Interpret your results.
5. Calculate the company’s RI. Interpret your results.
How does capacity affect transfer pricing decisions?
What is a transfer price?
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