Answers to the essay questions should be concise. For the problems you must show work. Submit answers using either Word or Excel. Make sure to label answers. The answer to a question must be either all Word or all Excel for that particular question. Format the Excel portion of the exam so that it may be easily printed.
1. (8 points) Pretty Lady is an upscale boutique that operates various stores throughout Florida. The company, which has three divisions (Miami, Naples, and Tampa), reported the following information for the year just ended (in thousands):
Pretty Lady also reported $600 of common fixed expenses that top management wants to allocate to the divisions on the basis of sales revenue. As the company's chief executive officer notes, “Each division helped to incur a portion of these costs and, as a result, each should absorb its fair share.” The firm has adopted various responsibility accounting procedures to evaluate division personnel.
A. Compute the company's total sales revenue.
B. Calculate the amount of variable operating expense incurred by the Naples Division.
C. Calculate the fixed costs controllable by Miami's management.
D. Calculate the fixed costs traceable to the Tampa Division but controllable by others.
E. Pretty Lady desires to promote a division manager to the corporate office to oversee selected operations. In determining which individual to promote, should Pretty Lady's top management focus on the profit margin controllable by the division manager or the overall divisional profit margin? Briefly explain.
F. If the company follows the desires of top management, how much of the common fixed expenses would be allocated to the Tampa Division?
G. Do cost allocations such as those in part “F” typically appear on a segmented income statement?
2. (6 points) Lee-Vie Company has met all production requirements for the current month and has an opportunity to manufacture additional units with its excess capacity. Unit selling prices and unit costs for three product lines follow.
Variable overhead is applied on the basis of direct labor dollars, whereas fixed overhead is applied on the basis of machine hours. There is sufficient demand for the additional manufacture of all products.
A. If Lee-Vie has excess machine capacity and can add more labor as needed (i.e., neither machine capacity nor labor is a constraint), which product is the most attractive to produce?
B. If Lee-Vie has excess machine capacity but a limited amount of labor time available, which product or products should be manufactured in the excess capacity?
3. (6 points) Greg Smithson builds custom homes in Cincinnati. Smithson was approached not too long ago by a client about a potential project, and he submitted a bid of $590,000, derived as follows:
Smithson adds a 25% profit margin to all jobs, computed on the basis of total cost. In this client's case the profit margin amounted to $118,000 ($472,000 25%), producing a bid price of $590,000. Assume that 60% of construction overhead is fixed.
A. Suppose that business is presently very slow, and the client countered with an offer on this home of $455,000. Should Smithson accept the client's offer? Why?
B. If Smithson has more business than he can handle, how much should he be willing to accept for the home? Why?
4. (8 points) Eagle Airways Company is planning a project that is expected to last for six years and generate annual net cash inflows of $75,000. The project will require the purchase of a $280,000 machine, which is expected to have a salvage value of $10,000 at the end of the six-year period. The machine will require a $50,000 overhaul at the end of the fourth year. The company presently has a 12% minimum desired rate of return.
Based on this information, an accountant prepared the following analysis:
The accountant recommends that the project be rejected because it does not meet the company's minimum desired rate of return. Ignore income taxes.
A. What criticism(s) would you make of the accountant's evaluation?
B. Use the net-present-value method and determine whether the project should be accepted.
C. Based on your answer in requirement “B,” is the internal rate of return greater or less than 12%? Explain.
5. (8 points) Jasper Corporation is organized in three separate divisions. The three divisional managers are evaluated at year-end, and bonuses are awarded based on ROI. Last year, the overall company produced a 12% return on its investment.
Managers of Jasper's Iowa Division recently studied an investment opportunity that would assist in the division's future growth. Relevant data follow.
A. Compute the current ROI of the Iowa Division and the division's ROI if the investment opportunity is pursued.
B. What is the likely reaction of divisional management toward the acquisition? Why?
C. What is the likely reaction of Jasper's corporate management toward the investment? Why?
D. Assume that Jasper uses residual income to evaluate performance and desires an 11% minimum return on invested capital. Compute the current residual income of the Iowa Division and the division's residual income if the investment is made. Will divisional management likely change its attitude toward the acquisition? Why?
6. (6 points) Gamma Division of Vaughn Corporation produces electric motors, 20% of which are sold to Vaughan's Omega Division and 80% to outside customers. Vaughn treats its divisions as profit centers and allows division managers to choose whether to sell to or buy from internal divisions. Corporate policy requires that all interdivisional sales and purchases be transferred at variable cost. Gamma Division's estimated sales and standard cost data for the year ended December 31, based on a capacity of 60,000 units, are as follows:
Gamma has an opportunity to sell the 12,000 units shown above to an outside customer at $80 per unit. Omega can purchase the units it needs from an outside supplier for $92 each.
A. Assuming that Gamma desires to maximize operating income, should it take on the new customer and discontinue sales to Omega? Why? (Note: Answer this question from Gamma's perspective.)
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