PART A:

Motor Company consists of four relatively autonomous divisions. In the past each division has concentrated on a relatively limited range of models designed to appeal to a particular segment of the automotive market. The Subaru division has been producing mid-sized cars for many years. They range in price (to dealers) from $14,000 to $25,300.

One day last August, Alexis, general manager of the Subaru Division, was studying some reports prepared by the company’s market research department at central headquarters. Alexis had been considering for some time the possibility of bringing out a stripped-down version of the divisions most popular model, the Sambro. Alexis had been hesitant to do so because she feared that sales of the higher priced Sambro would suffer. The market research indicated, however, that lost sales of higher priced versions would be negligible if a new Sambro were introduced and priced to sell to the customer for about $20,800. The lowest price at retail now charged for a Sambro is $24,700.

Alexis was pleased at the results of the study and instructed her production manager, Tim, to determine the cost of producing 80,000 units of the new model per year. This is the number of units that the study indicated could be sold. Alexis also asked for information about additional investment in equipment, inventories, and receivables necessitated for the higher volume.

A few days later Alexis had the additional information. Tim estimated the cost per unit to be $17,800, composed of the following base categories:

Variable costs $13,800

Fixed costs 4,000

Total $17,800

The fixed cost per-unit included $100,000,000 in existing fixed costs that would be reallocated to the new model under a complicated formula instigated by the division’s comptroller Kazue Fukiishi. The additional investment in equipment was $300,000,000 and in receivables $200,000,000.

Alexis was reasonably certain that the information gathered was as accurate as estimates are likely to be. She consulted with several large dealers and concluded that the model could be priced at $18,100 to dealers. Any higher price would encourage the dealers to charge more than $20,800, with a consequent decline in volume below the 80,000 per-year target.

Like other division managers, Alexis is valuated based on the residual income earned by her division. The minimum required return is 18%. Income taxes are ignored in determining residual income for the divisions.

REQUIRED:

Determine whether the new Sambro should be brought out. Please support by calculations and an in-depth narrative.

PART B:

While thinking about her decision whether to introduce the new Sambro model. Alexis was eating lunch with Yanka, general manager of the Zutashi Division, which specializes in compact and subcompact cars. Alexis told Yanka about the study she had ordered and gave a general picture of the results including the projection of 80,000 units of the new model.

After lunch Yanka called Milo, the chief of market research for the company and politely asked for more information about the study. Milo said that the study indicated a potential decline in volume of 30,000 units of one of Zutashi Division’s best-selling higher priced models if Subaru Division brought out the new lower priced model. Yanka asked why the hell that information had not been included in the report given to Alexis? She was told that Alexis had only asked for estimates in declines in volume of Subaru Division cars and didn’t care how it will affect the other divisions.

Yanka then immediately texted her production manager and sales manager. She informed them of the situation and demanded that they quickly collect information.

Several weeks later the production manager, Yata, informed Yanka that the model in question, the Tenzan, which sold to retail dealers for $16,700, had unit costs of $16,400 at the division’s current volume of 160,000 units per year. Fixed costs of $3,500 were included in the $16,400 figure. Ms. Yanka asked what savings in fixed costs might be expected if the volume were to fall by 30,000 units and was told that the fixed cost per unit would rise to about $4,000 even though some fixed cost could be eliminated. Conversations with other managers revealed that the division’s investment could be reduced by about $100,000,000 if volume fell as stated.

Yanka was visibly tormented by what she heard. She was concerned with her division’s interests, but realized that Alexis had the right to operate in accordance with her best interests. She pondered the possibility of going to the company’s president, Andrew, to put a stop to this.

REQUIRED:

1. Determine the effect on Zutashi Division of the introduction of the new Sambro.
2. Determine the effect on the company of the introduction of the new Sambro. Support your argument.
3. If the divisions were not autonomous would this be a problem?
4. Should the company’s comptroller, be consulted?
5. Does Yanka of a valid reason for bringing this to Andrew’s attention?