AKUNTANSI

MANAJEMEN
2018
 These questions are taken from Honrngren’s Cost Accounting: A Managerial Emphasis 15th Edition.

11-19 Special order, activity-based costing. (CMA, adapted)

The Gold Plus Company manufactures medals for winners of athletic events and other contests. Its
manufacturing plant has the capacity to produce 11,000 medals each month. Current production and
sales are 10,000 medals per month. The company normally charges $150 per medal. Cost information
for the current activity level is as follows:

Variable costs that vary with number of units produced

Direct materials $ 350,000

Direct manufacturing labor 375,000
Variable costs (for setups, materials handling, quality control, and so on)
that vary with number of batches, 200 batches x $500 per batch 100,000
Fixed manufacturing costs 300,000
Fixed marketing costs 275,000
Total costs $1,400,000

Gold Plus has just received a special one-time-only order for 1,000 medals at $100 per medal.
Accepting the special order would not affect the company’s regular business. Gold Plus makes medals
for its existing customers in batch sizes of 50 medals (200 batches * 50 medals per batch = 10,000
medals). The special order requires Gold Plus to make the medals in 25 batches of 40 medals.

1. Should Gold Plus accept this special order? Show your calculations.
2. Suppose plant capacity were only 10,500 medals instead of 11,000 medals each month. The
special order must either be taken in full or be rejected completely. Should Gold Plus accept
the special order? Show your calculations.
3. As in requirement 1, assume that monthly capacity is 11,000 medals. Gold Plus is concerned
that if it accepts the special order, its existing customers will immediately demand a price
discount of $10 in the month in which the special order is being filled. They would argue that
Gold Plus’s capacity costs are now being spread over more units and that existing customers
should get the benefit of these lower costs. Should Gold Plus accept the special order under
these conditions? Show your calculations.

Answers:

1. Should Gold Plus accept the special one-time only order for 1,000 medals at $100 per medal?

Incremental revenue $100 1.000 $100.000

Incremental costs:
Variable manufacturing costs

Direct materials ($35) 1.000 ($35.000)

Direct manufacturing labor ($37,50) 1.000 -37.500

Batch setup costs ($500) 25 -12.500 -85.000

$135,00
 Incremental increase in operating income $15.000

Gold Plus should accept the one-time-only special order provided that there are no long-term
implications. If accepting the special order would cause the regular customers to be dissatisfied or to
demand lower prices, then Gold Plus will have to trade off the $15,000 profit increase from accepting
the special order against the operating income that might be lost from regular customers.

2. Suppose plant capacity was only 10,500 medals instead of 11,000 medals each month. The special
order must either be taken in full or be rejected completely. Should Gold Plus accept the special
order?

Proposed Current Batch size Batches Req.

Total production capacity 10.500 10.500

Capacity used for normal customers 10.000 50 200

Capacity usage with special order

Needed fo special order 1.000 40 25

Available for regular customers 9.500 50 190

Excess Capacity 0 500

Units SP/Costs Total

Lost revenue from regular customers -500 $150,00 ($75.000)

Variable manufacturing costs saved

Direct materials 500 $35,00 17.500

Direct manufacturing labor 500 $37,50 18.750

Batch setup costs saved 10 $500,00 5.000

Decrease in opr income reg cstmrs ($33.750)

Incremental revenue from spcl order 1.000 $100,00 $100.000

Incremental costs

Variable manufacturing costs

Direct materials 1.000 ($35,00) ($35.000)

Direct mnfct labor 1.000 ($37,50) -37.500

 Batch setup costs 25 ($500,00) -12.500

Increase in operating income from special order 15.000

Net benefit of accepting special order ($18.750)

The special order should be rejected because if accepted operating income would decrease
by $18,750.
Note: Even if operating income had increased by accepting the special order, Gold Plus should
consider the effect on its regular customers of accepting the special order. For example, would selling
500 fewer medals to its regular customers cause these customers to find new suppliers that might
adversely impact Gold Plus’s business in the long run.

3. As in requirement 1, assume that monthly capacity is 11,000 medals. Gold Plus is concerned that if it
accepts the special order, its existing customers will immediately demand a price discount of $10 in
the month in which the special order is being filled. They would argue that Gold Plus's capacity costs
are now being spread over more units and that existing customers should get the benefit of these
lower costs. Should Gold Plus accept the special order under these conditions?

Incremental revenue from special order 1.000 $100 $100.000

Incremental costs from special order

Variable manufacturing costs

Direct materials 1.000 ($35,00) ($35.000)

Direct manufacturing labor 1.000 ($37,50) -37.500

Batch setup costs 25 ($500,00) -12.500 -85.000

Incremental increase in operating income from special order $15.000

Less decrease in operating income generated from normal sales -100.000

Net decrease in operating income if special order is accepted ($85.000)

The special order should, therefore, be rejected

11-20 Make versus buy, activity-based costing.

 The Svenson Corporation manufactures cellular modems. It manufactures its own cellular modem
circuit boards (CMCB), an
important part of the
cellular modem. It reports
the following cost
information about the
costs of making CMCBs in
2014 and the expected
costs in 2015:

Svenson manufactured 8,000 CMCBs in 2014 in 40 batches of 200 each. In 2015, Svenson anticipates
needing 10,000 CMCBs. The CMCBs would be produced in 80 batches of 125 each.

The Minton Corporation has approached Svenson about supplying CMCBs to Svenson in 2015
at $300 per CMCB on whatever delivery schedule Svenson wants.

1. Calculate the total expected manufacturing cost per unit of making CMCBs in 2015.
2. Suppose the capacity currently used to make CMCBs will become idle if Svenson purchases
CMCBs from Minton. On the basis of financial considerations alone, should Svenson make
CMCBs or buy them from Minton? Show your calculations.
3. Now suppose that if Svenson purchases CMCBs from Minton, its best alternative use of the
capacity currently used for CMCBs is to make and sell special circuit boards (CB3s) to the Essex
Corporation. Svenson estimates the following incremental revenues and costs from CB3s:
Total expected incremental future revenues $2,000,000
Total expected incremental future costs $2,150,000
On the basis of financial considerations alone, should Svenson make CMCBs or buy them from
Minton? Show your calculations.

Answers:
1. Calculate the total expected manufacturing cost per unit of making CMCBs in 2015.

Production Level 10.000

Variable manufacturing costs

Direct materials cost per unit $170

Direct manufacturing labor 45

Batch costs (setups, materials handling and quality control) $120.000 12

Fixed Costs

Avoidable Costs $320.000 32

Unavoidable Costs $800.000 80

Total expected mfg. cost per unit to manufacture 10,000 units $339
2. Suppose the capacity currently used to make CMCBs will become idle if Svenson purchases CMCBs
from Minton. On the basis of financial considerations alone, should Svenson make CMCBs or buy
them from Minton?

Incremental cost per unit if purchased from Minton $300

Incremental cost savings per unit by not producing CMCBs internally

Variable manufacturing costs saved by not producing CMCBs internally

Direct materials cost per unit $170

Direct manufacturing labor 45

Unit batch costs (setups, materials handling and quality control) $120.000 12

Fixed Costs

Avoidable Costs (1) $320.000 32

Incremental mfg. costs per unit saved by not producing CMCBs $259

Disadvantage of buying CMCBs and having freed capacity remain idle $41

(1) Note: The unavoidable fixed costs of $800,000 will continue to be incurred regardless of
the decision to make or buy. These costs are therefore, irrelevant to the decision at
hand.

3. On the basis of financial considerations alone, should Svenson make CMCBs or buy them from
Minton?
Incremental cost of producing CMCBs internally $259

Net cost of buying and using freed capacity to produce CB3s

Cost of buying from CMCBs Minton $300

Net benefit/loss of using freed capacity to produce CB3s.

Incremental revenue associated with CB3s $2.000.000
Incremental costs associated with CB3s 2.150.000
Net loss associated with producing CB3s ($150.000)
Extra cost per unit to be absorbed by the 10,000 CMCBs 15

Net cost of buying CMCBs and using freed capacity to produce CB3s. $315

Disadvantage of buying CMCBs from Minton and producing and selling CB3s $56

Note: As long as producing CB3s yields a net loss, Svenson should just produce CMCBs.

$3.000.000
11-24 Theory of constraints, throughput margin, relevant costs.

The Pierce Corporation manufactures filing cabinets in two operations: machining and finishing. It
provides the following information:

Each cabinet sells for $70 and has direct material costs of $30 incurred at the start of the machining
operation. Pierce has no other variable costs. Pierce can sell whatever output it produces. The
following requirements refer only to the preceding data. There is no connection between the
requirements.

1. Pierce is considering using some modern jigs and tools in the finishing operation that would
increase annual finishing output by 1,150 units. The annual cost of these jigs and tools is
$35,000. Should Pierce acquire these tools? Show your calculations.
2. The production manager of the Machining Department has submitted a proposal to do faster
setups that would increase the annual capacity of the Machining Department by 9,000 units
and would cost $4,000 per year. Should Pierce implement the change? Show your calculations.
3. An outside contractor offers to do the finishing operation for 9,500 units at $9 per unit, triple
the $3 per unit that it costs Pierce to do the finishing in-house. Should Pierce accept the
subcontractor’s offer? Show your calculations.
4. The Hammond Corporation offers to machine 5,000 units at $3 per unit, half the $6 per unit
that it costs Pierce to do the machining in-house. Should Pierce accept Hammond’s offer?
Show your calculations.
5. Pierce produces 1,700 defective units at the machining operation. What is the cost to Pierce
of the defective items produced? Explain your answer briefly.
6. Pierce produces 1,700 defective units at the finishing operation. What is the cost to Pierce of
the defective items produced? Explain your answer briefly.

Answers:
1. Should Pierce acquire these tools ?
Finishing is a bottleneck. Modern jigs and tools would relax the bottleneck by 1,150 units.
Benefit of modern jigs and tools:
Additional contribution margin generated $46.000
Incremental fixed costs associated with tools -35.000
Net advantage of buying modern jigs and tools $11.000

Recommendation: Buy modern jigs and tools

2. Should Pierce implement the change ?

Machining already has excess capacity and is therefore not a bottleneck operation. Increasing
its capacity further will not increase throughput contribution.Therefore, there is no benefit
from spending $4,000 to increase the Machining Department's capacity by 9,000 units.
 Recommendation: Do not implement the change to do faster setups.

3. Should Pierce accept the subtractor’s offer ?

Finishing is a bottleneck operation. Accepting the outside contractor's offer will increase
output by 9,500 units.
Advantage of accepting
Additional Throughput CM from increased sales $380.000
Cost of outside finishing -85.500
Net advantage of accepting the offer $294.500
Recommendation: Accept the offer.

4. Should Pierce accept the subtractor’s offer ?

If Pierce provides the materials to be converted, there is no variable cost savings by accepting
Hammond Corporation's offer. All other costs incurred by Pierce are fixed. Therefore, there
is no cost savings by accepting the Hammond offer. In addition, since the machining
department is not a bottleneck, no additional throughput contribution will be generated by
accepting the offer from Hammond Corporation. Sales is limited by the capacity of the
finishing department. If the offer is accepted, costs will increase by 5,000 X $3 = $15,000.

Recommendation: Reject the Hammond offer.

5. What is The cost to Pierce of the defective items produced ?

Machining is not a bottleneck operation. Producing 1,700 defective units does not reduce
throughput contribution; machining can still produce and transfer 90,000 good units to
finishing. Therefore, the cost of the defective units is $30 X 1,700 = $51,000.

6. What is The cost to Pierce of the defective items produced ?

Finishing is a bottleneck operation. Producing 1,700 defective units in the bottleneck
operation will reduce throughput contribution. Therefore, the cost of the defective units is:
1,700 X $70 = $119.000

11-26 Choosing customers.

Rodeo Printers operates a printing press with a monthly capacity of 4,000 machine-hours. Rodeo has
two main customers: Trent Corporation and Julie Corporation. Data on each customer for January
are:

Trent Corporation Julie Corporation Total

Revenues $210,000 $140,000 $350,000
Variable costs 84,000 85,000 169,000

Contribution margin 126,000 55,000 181,000

Fixed costs (allocated) 102,000 68,000 170,000

Operating income $ 24,000 $ (13,000) $ 11,000

Machine-hours 3,000 hours 1,000 hours 4,000 hours

required
Julie Corporation indicates that it wants Rodeo to do an additional $140,000 worth of printing jobs
during February. These jobs are identical to the existing business Rodeo did for Julie in January in
terms of variable costs and machine-hours required. Rodeo anticipates that the business from Trent
Corporation in February will be the same as that in January. Rodeo can choose to accept as much of
the Trent and Julie business for February as its capacity allows. Assume that total machine-hours and
fixed costs for February will be the same as in January.
What action should Rodeo take to maximize its operating income? Show your calculations. What
other factors
should Rodeo consider before making a decision?

Answers:

If Rodeo accepts the additional business from Julie, it would take an additional 500 machine hours. If
Rodeo accepts all of Julie’s and Trent’s business for February, it would require 5,000 machine-hours
(3,000 hours for Trent and 2,000 hours for Julie). Rodeo has only 4,000 hours of machine capacity. It
must, therefore, choose how much of the Trent or Julie business to accept.

To maximize operating income, Rodeo should maximize contribution margin per unit of the
constrained resource. (Fixed costs will remain unchanged at $170,000 regardless of the business
Rodeo chooses to accept in February and are, therefore, irrelevant.) The contribution margin per unit
of the constrained resource for each customer in January is:

Trent Corporation Julie Corporation

Contribution margin per machine-hour $126,000/3,000 = $42 $55,000/1,000 = $55

Because the $140,000 of additional Julie business in February is identical to jobs done in January, it
will also have a contribution margin of $55 per machine-hour, which is greater than the contribution
margin of $42 per machine-hour from Trent. To maximize operating income, Rodeo should first
allocate all the capacity needed to take the Julie Corporation business (2,000 machine-hours) and then
allocate the remaining 2,000 (4,000 – 2,000) machine-hours to Trent.

Trent Julie Corporation Total

Corporation
Contribution margin per machine-hour $42 $55
Machine-hours to be worked × 2,000 × 2,000
Contribution margin $84,000 $110,000 $194,000
Fixed costs $170,000
Operating income $ 24,000

An alternative approach is to use the opportunity cost approach. The opportunity cost of giving up
1,000 machine-hours for the Trent Corporation jobs is the contribution margin forgone of $42 per
machine-hour × 1,000 machine-hours equal to $42,000. The contribution margin gained from using
the 1,000 machine-hours for the Julie Corporation business is the contribution margin per machine-
hour of $55 × 1,000 machine-hours equal to $55,000.

The net benefit is:

Contribution margin from Julie Corporation business $55,000
 Less: Opportunity cost (of giving up Trent Corporation business) (42,000)
Net benefit $13,000

Although taking the Julie Corporation business over the Trent Corporation business will maximize
Rodeo’s profits in the short run, Rodeo’s managers must also consider the long-run effects of this
decision. Will Julie Corporation continue to demand the same level of business going forward? Will
turning down the Trent business affect customer satisfaction? If Rodeo turns down the Trent business,
will Trent continue to place orders with Rodeo or seek alternative suppliers? Rodeo’s managers need
to consider these long-run effects and then decide whether it should accept Julie’s business at the
cost of Trent’s. In other words, choosing customers is a strategic decision. If it sees long-run benefit in
working with Trent, Rodeo’s managers must also look for ways to increase the profitability of the
business it does with Trent by increasing prices or reducing costs.

13-18 Target prices, target costs, activity-based costing.

Snappy Tiles is a small distributor of marble tiles. Snappy identifies its three major activities and cost
pools as ordering, receiving and storage, and shipping, and it reports the following details for 2013:

Activity Cost Driver Cost Driver Quantity of Cost Driver Cost per Unit of Cost
Driver

1. Placing and paying for Number of 500 $50 per order

orders of marble tiles orders
2. Receiving and storage Loads moved 4,000 $30 per load

3. Shipping of marble $40 per shipment

tiles to retailers Number of 1,500
shipments

For 2013, Snappy buys 250,000 marble tiles at an average cost of $3 per tile and sells them to retailers
at an average price of $4 per tile. Assume Snappy has no fixed costs and no inventories.

1. Calculate Snappy’s operating income for 2013.

2. For 2014, retailers are demanding a 5% discount off the 2013 price. Snappy’s suppliers are only
willing to give a 4% discount. Snappy expects to sell the same quantity of marble tiles in 2014 as in
2013. If all other costs and cost-driver information remain the same, calculate Snappy’s operating
income for 2014.
3. Suppose further that Snappy decides to make changes in its ordering and receiving-and-storing
practices. By placing long-run orders with its key suppliers, Snappy expects to reduce the number of
orders to 200 and the cost per order to $25 per order. By redesigning the layout of the warehouse and
reconfiguring the crates in which the marble tiles are moved, Snappy expects to reduce the number
of loads moved to 3,125 and the cost per load moved to $28. Will Snappy achieve its target operating
income of $0.30 per tile in 2014? Show your calculations.

Answers:

1. Snappy’s operating income in 2013 is as follows:

Total for 250,000 Tiles Per Unit

(1) (2) = (1) ÷ 250,000
 Revenues ($4×250,000) $1,000,000 $4.00

Purchase cost of tiles ($3× 250,000) 750,000 3.00

Ordering costs ($50 × 500) 25,000 0.10

Receiving and storage ($30 × 4,000) 120,000 0.48

Shipping ($40 × 1,500) 60,000 0.24

Total costs 955,000 3.82

Operating income $ 45,000 $0.18

2. Price to retailers in 2014 is 95% of 2013 price = 0.95 × $4 = $3.80; cost per tile in 2014 is
96% of 2013 cost = 0.96 × $3 = $2.88.
Snappy’s operating income in 2014 is as follows:

Total for 250,000 Tiles Per Unit

(1) (2) = (1) ÷ 250,000

Revenues ($3.80×250,000) $950,000 $3.80

Purchase cost of tiles ($2.88×250,000) 720,000 2.88

Ordering costs ($50×500) 25,000 0.10

Receiving and storage ($30×4,000) 120,000 0.48

Shipping ($40×1,500) 60,000 0.24

Total costs 925,000 3.70

Operating income $ 25,000 $0.10

3. Snappy’s operating income in 2014 if it makes changes in ordering and material handling,
will be as follows:

Total for 250,000 Tiles Per Unit

(1) (2) = (1) ÷ 250,000

Revenues ($3.80×250,000) $950,000 $3.80

Purchase cost of tiles ($2.88×250,000) 720,000 2.88

Ordering costs ($25×200) 5,000 0.02

 Receiving and storage ($28 ×3,125) 87,500 0.35

Shipping ($40 ×1,500) 60,000 0.24

Total costs 872,500 3.49

Operating income $ 77,500 $0.31

Through better cost management, Snappy will be able to achieve its target operating income of
$0.30 per tile despite the fact that its revenue per tile has decreased by $0.20 ($4.00 – $3.80),
while its purchase cost per tile has decreased by only $0.12 ($3.00 – $2.88).

14-22 Cost allocation to divisions.

Holbrook Corporation has three divisions: pulp, paper, and fibers. Holbrook’s new controller, Paul
Weber, is reviewing the allocation of fixed corporate-overhead costs to the three divisions. He is
presented with the following information for each division for 2013:

Until now, Holbrook Corporation has allocated fixed corporate-overhead costs to the divisions on
the basis of division margins. Weber asks for a list of costs that comprise fixed corporate overhead
and suggests the following new allocation bases:

1. Allocate
2013 fixed corporate-overhead costs to the three divisions using division margin as the
allocation base. What is each division’s operating margin percentage (division margin minus
allocated fixed corporate-overhead costs as a percentage of revenues)?
2. Allocate 2013 fixed costs using the allocation bases suggested by Weber. What is each
division’s operating margin percentage under the new allocation scheme?
3. Compare and discuss the results of requirements 1 and 2. If division performance is linked to
operating margin percentage, which division would be most receptive to the new allocation
scheme? Which division would be the least receptive? Why?
4. Which allocation scheme should Holbrook Corporation use? Why? How might Weber
overcome any objections that may arise from the divisions?

Answers:

Required:
1. Allocate 2013 fixed corporate-overhead costs to the 3 divisions using division margin as the
allocation base. What is each division's operating margin % (division margin minus allocated
fixed corporate-overhead costs as a percentage of revenue)?
Pulp Paper Fibers Total
Allocated corporate- $1.515.000 $3.686.500 $4.898.500 $10.100.000
overhead costs

Pulp Paper Fibers Total

Division margin $3.000.000 $7.300.000 $9.700.000 $20.000.000
Allocated corporate- 1.515.000 3.686.500 4.898.500 10.100.000
overhead costs
Division operating margin $1.485.000 $3.613.500 $4.801.500 $9.900.000
Division operating margin
percentage 15,15% 21,13% 18,83% 18,89%

2. Allocate 2013 fixed costs using the allocation bases suggested by Weber. What is each
division's operating margin percentage under the new allocation scheme?

Pulp Paper Fibers Total

Human resource mgmt.
costs $690.000 $345.000 $1.265.000 $2.300.000
Facility costs $896.000 $595.200 $1.708.800 3.200.000
Corporate administrative
costs 1.518.000 920.000 2.162.000 4.600.000
Total Indirect FOH Costs $3.104.000 $1.860.200 $5.135.800 $10.100.000

Pulp Paper Fibers Total

Division margin $3.000.000 $7.300.000 $9.700.000 $20.000.000
Allocated corporate-
overhead costs 3.104.000 1.860.200 5.135.800 10.100.000
Division operating margin ($104.000) $5.439.800 $4.564.200 $9.900.000
Division operating margin
percentage -1,06% 31,81% 17,90% 18,89%

3. Compare and discuss the results of requirements 1 and 2. If division performance is linked
to operating margin %, which division would be most receptive to the new allocation scheme?
Which division would be the least receptive? Why?

When corporate overhead is allocated to the divisions on the basis of division margins
(requirement 1), each division appears profitable each having positive operating margin. The
Paper division appears the most profitable having the highest operating margin % while the
Pulp division appears least profitable. When Weber's suggested bases are used to allocate
fixed corporate-overhead costs (requirement 2), the Pulp division appears unprofitable having
a negative operating %. Paper appears to be the most profitable -- significantly more
profitable than the Fibers Division.
 4. Which allocation scheme should Holbrook Corporation use? Why? How might Weber
overcome any objections that may arise from the divisions?

The new approach is preferable because the indirect FOH costs are divided into three
homogeneous cost pools with distinctive cost drivers. These drivers are used to allocate the
cost pool costs based on cause-and-effect relationships. The old method used division margins
which are the result of cost relationships not the cause of them.

The cost drivers used are based on logical cause and effect relationships. For example:
a. HR costs are allocated using the number of employees in each division because the costs
for recruitment, training, etc., are mostly related to the number of employees in each
division
b. Facility costs are mostly incurred on the basis of space occupied by each division.
c. Corporate administrative costs are allocated on the basis of divisional administrative costs
because these costs are incurred to provide support to divisional administrations.

To overcome objections from the divisions, Weber may initially choose not to allocate
corporate overhead to divisions when evaluating performance. He could start by sharing the
results with the divisions, and giving them—particularly the Pulp division—adequate time to
figure out how to reduce their share of cost drivers. He should also develop benchmarks by
comparing the consumption of corporate resources to competitors and other industry
standards

22-21 Effect of alternative transfer-pricing methods on division operating income.

Ajax Corporation has two divisions. The mining division makes toldine, which is then
transferred to the metals division. The toldine is further processed by the metals division and is sold
to customers at a price of $150 per unit. The mining division is currently required by Ajax to transfer
its total yearly output of 200,000 units of toldine to the metals division at 110% of full manufacturing
cost. Unlimited quantities of toldine can be purchased and sold on the outside market at $90 per unit.
The following table gives the manufacturing cost per unit in the mining and metals divisions for 2014:

Mining Division Metal Division

Direct material cost $12 $6
Direct manufacturing labor cost $16 $20
Manufacturing overhead cost $32a $25b
Total manufacturing cost $60 $51
a
Manufacturing overhead costs in the mining division are 25% fixed and 75% variable.
b
Manufacturing overhead costs in the metals division are 60% fixed and 40% variable.

1. Calculate the operating incomes for the mining and metals divisions for the 200,000 units of
toldine transferred under the following transfer-pricing methods: (a) market price and (b) 110%
of full manufacturing cost.
2. Suppose Ajax rewards each division manager with a bonus, calculated as 1% of division operating
income (if positive). What is the amount of bonus that will be paid to each division manager under
the transfer-pricing methods in requirement 1? Which transfer-pricing method will each division
manager prefer to use?
3. What arguments would Brian Jones, manager of the mining division, make to support the
transferpricing method that he prefers?
 22-21 Effect of alternative transfer-pricing methods on division operating income.
1.
Mining Division (a) Market Price (b) 110% of Full Cost
Revenues $90 x 200.000 = $18,000,000 $60 x 110% x 200.000 = $13,200,000
$(12+16+(32x75%)) x 200.000 $(12+16+(32x75%)) x 200.000
Variable Costs = $10,400,000 = $10,400,000
Fixed Costs $(32x25%) x 200.000 = $1,600,000 $(32x25%) x 200.000 = $1,600,000
Operating
Income $6,000,000 $1,200,000

Metal Division (a) Market Price (b) 110% of Full Cost

Revenues $150 x 200.000 = $30,000,000 $150 x 200.000 = $30,000,000
Transferred in
Costs Revenues Mining Division = $18,000,000 Revenues Mining Division = $13,200,000
Variable Costs $(6+20+(25x40%)) x 200.000 = $7,200,000 $(6+20+(25x40%)) x 200.000 = $7,200,000
Fixed Costs $(25x60%) x 200.000 = $3,000,000 $(25x60%) x 200.000 = $3,000,000
Operating
Income $1,800,000 $6,600,000

2. Bonus paid to division managers at 1% of division operating income will be as follows:

Operating Income (a) Market Price (b) 110% of Full Cost
Mining Division $6,000,000 x 1% = $60,000 $1,200,000 x 1% = $12,000
Metal Division $1,800,000 x 1% = $18,000 $6,600,000 x 1% = $66,000
The Mining Division manager will prefer Method A (transfer at market prices) because this method
gives him $60,000 of bonus rather than $12,000 under Method B (transfers at 110% of full costs). The
Metals Division manager will prefer Method B because this method provides $66,000 of bonus rather
than $18,000 under Method A.

3.
• Brian Jones, the manager of the Mining Division, will appeal to the existence of a competitive
market to price transfers at market prices. Using market prices for transfers in these
conditions leads to goal congruence. Division managers acting in their own best interests
make decisions that are also in the best interests of the company as a whole.
• Jones will further argue that setting transfer prices based on cost will cause him to pay no
attention to controlling costs because all costs incurred will be recovered from the Metals
Division at 110% of full costs.
23-20 ROI, RI, EVA.
Hamilton Corp. is a reinsurance and financial services company. Hamilton strongly believes in
evaluating the performance of its standalone divisions using financial metrics such as ROI and residual
income. For the year ended December 31, 2013, Hamilton’s CFO received the following information
about the performance of the property/casualty division:

Sales revenues $1,200,000

Operating income $200,000
Total assets $1,250,000
Current liabilities $250,000
Debt (interest rate: 6.25%) $600,000
Common equity $400,000

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 20% in taxes on its income.

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 10%, what was the property/casualty division’s
residual income for 2013?
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 twice that
of its book value. The company’s cost of equity capital is 12%. Calculate each of the following
components of EVA for the property/casualty division, as well as the final EVA figure:
a. Net operating profit after taxes.
b. Weighted-average cost of capital.
c. Investment, as measured for EVA calculations.
23-20 ROI, RI, EVA

1.

Operating Income (Given) $200,000

Interest Expenses 6.25% x $600,000 = $37,500
Earning Before Tax $200,000 - $37,500 = $162,500
Income Taxes 20% x $162,500 = $32,500
Net Income After Taxes $162,500 - $32,500 = $130,000

./0123
2. Return on Investment = ./435623/6 × 100%

Hamilton defines investment as total assets and income as operating income (that is, income before
interest and taxes).
$200,000
Return on Investment = × 100% = 16%
$1,250,000

3. Residual Income = Income − (Required rate of return × Investment)

Residual Income = $200,000 − (10% × $1,250,000) = $75,000

4.

a. Net operating profit after taxes = Operating Income × (1 − Tax rate)

Net operating profit after taxes = $200,000 × (1 − 20%) = $160,000
b. Market value of Debt = $600,000
After tax cost of Debt = 6.25% × (1 − Tax rate) = 6.25% × 80% = 5%
Market value of Equity = $400,000 × 2 = $800,000
Cost of Equity = 12%
($600,000 × 5%) + ($800,000 × 12%)
Weighted average cost of capital = = 9%
$600,000 + $800,000
c. Investment = Total Asset − Current liabilities = $1,250,000 − $250,000 = $1,000,000

Therefore, Economic Value Added = $160,000 − 9% × $1,000,000 = $70,000

12-18 Strategy, balanced scorecard, merchandising operation.
Ramiro & Sons buys T-shirts in bulk, applies its own trendsetting silk-screen designs, and then
sells the T-shirts to a number of retailers. Ramiro wants to be known for its trendsetting designs, and
it wants every teenager to be seen in a distinctive Ramiro T-shirt. Ramiro presents the following data
for its first two years of operations, 2012 and 2013.

2012 2013
1 Number of T-shirts purchased 225,500 257,000
2 Number of T-shirts discarded 20,500 24,000
3 Number of T-shirts sold 205,000 233,000
4 Average selling price $32 $33
5 Average cost per T-shirt $17 $15
6 Administrative capacity (number of customers) 4,700 4,450
7 Administrative costs $1,739,000 $1,691,000
8 Administrative cost per customer $370 $380

Administrative costs depend on the number of customers Ramiro has created capacity to
support, not on the actual number of customers served. Ramiro had 4,300 customers in 2012 and
4,200 customers in 2013.

1. Is Ramiro’s strategy one of product differentiation or cost leadership? Explain briefly.

2. Describe briefly the key measures Ramiro should include in its balanced scorecard and the
reasons for doing so.
12-18 Strategy, balanced scorecard, merchandising operation.
1. Ramiro & Sons follows a product differentiation strategy. Ramiro’s designs are “trendsetting,” its
T-shirts are distinctive, and it aims to make its T-shirts a “must have” for each and every teenager.
These are all clear signs of a product differentiation strategy, and to succeed, Ramiro must continue
to innovate and be able to charge a premium price for its product.

2. Possible key elements of Ramiro’s balance scorecard, given its product differentiation strategy:

Financial Perspective
i. Increase in operating income from charging higher margins.
ii. Price premium earned on products.
These measures will indicate whether Ramiro has been able to charge premium prices and achieve
operating income increases through product differentiation.

Customer Perspective
i. Market share in distinctive, name-brand T-shirts.
ii. Customer satisfaction.
iii. New customers.
iv. Number of mentions of Ramiro’s T-shirts in the leading fashion magazines.
Ramiro’s strategy should result in improvements in these customer measures that help evaluate
whether Ramiro’s product differentiation strategy is succeeding with its customers. These measures
are, in turn, leading indicators of superior financial performance.

Internal Business Process Perspective

i. Quality of silk-screening (number of colors, use of glitter, durability of the design).
ii. Frequency of new designs.
iii. Time between concept and delivery of design.
Improvements in these measures are expected to result in more distinctive and trendsetting designs
delivered to its customers and in turn, superior financial performance.

Learning and Growth Perspective

i. Ability to attract and retain talented designers.
ii. Improvements in silk-screening processes.
iii. Continuous education and skill levels of marketing and sales staff.
iv. Employee satisfaction Improvements in these measures are expected to improve.
Ramiro’s capabilities to produce distinctive designs that have a cause-and-effect relationship with
improvements in internal business processes, which in turn lead to customer satisfaction and financial
performance.