Peters of Persia sells fabric to a wide range of industrial and consumer users. One of the products it carries is denim cloth, used in the manufacture of jeans and carry bags. The supplier for the denim cloth pays all incoming freight. No incoming inspection of the denim is necessary because the supplier has a track record of delivering high-quality merchandise. The purchasing officer has collected the following information:

Question 4

Annual demand for denim cloth 27,500 metres Ordering cost per purchase order $195 Carrying cost per year Safety-stock requirements Cost of denim cloth

22.5% of purchase cost none

$14.75 per metre

The purchasing lead time is two weeks. Peters of Persia is open 250 days a year (50 weeks for 5 days a week).

Required:

(a) Calculate the economic order quantity (EOQ) for denim cloth. (2.5 marks)

(b) Calculate the number of orders that will be placed each year. (1 mark)

(c) Calculate the reorder point for denim cloth. (1.5 marks)

Clear Windows manufactures windows for the home building industry. The window frames are produced in the Frame Division at a variable production cost of $190 per unit. The frames are then transferred to the Glass Division, where glass and hardware are installed to make the windows. The Glass Division incurs a variable cost of $310 per unit in addition to the transfer price of the Frame Division. The fixed production cost in each division is 30% of the variable production cost.

The Frame Division can also sell frames to custom home builders at a price of $250 per unit, but it will incur a selling expense of $5 per unit. The Glass Division sells its finished windows for $570 per unit.

Required:

(a) Assume that the Frame Division has spare capacity. Calculate the transfer price using the general rule. (1 mark)

(b) Assume that the Frame Division has no spare capacity. Calculate the transfer price using the general rule. (2 marks)

(c) Assume that the Frame Division has spare capacity. Calculate the transfer price if it is based on absorption cost plus a 10% markup. Would the manager of the Glass Division accept this transfer price? (3 marks)

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(d) Assume that the Frame Division has limited spare capacity and can only supply half of the required 200 frames to the Glass Division. To supply all of the 200 units to the Glass Division, the Frame Division would have to forgo production and sales of 140 units of another product to external customers. These external sales typically yield a contribution of $110 per unit. Use the general rule to calculate the transfer price. (2 marks)

(e) Assume that the Frame Division has spare capacity, and the transfer price is based on variable production cost plus a 20% markup. The Glass Division has been approached by a construction company with a special order for 1,000 windows at $520 each. Is this offer in the best interests of the organisation as a whole? Would an autonomous Glass Division manager accept the special offer? Does this transfer price achieve goal congruence? (5 marks)

Telum Ltd manufactures electronic devices and competes on the basis of quality and leading- edge designs. The company has $1,750,000 invested in assets in its Mobile Phone Division. The operating profit before tax of the Mobile Phone Division this year is $325,000. The Tablet Division has $6,000,000 invested in assets and an operating profit before tax this year of $1,050,000. The weighted average cost of capital for Telum (which is also the required rate of return) is 9%. The CEO of Telum Ltd has told the manager of each division that the division that "performs best" this year will get a bonus.

Required:

(a) Calculate the return on investment (ROI) and residual income (RI) for each division, and briefly explain which manager will get the bonus based on these two measures. (3 marks)

(b) The manager of the Tablet Division is considering a proposal to invest $120,000 in a new quality testing system. It is estimated that the new system will decrease operating costs (and hence increase profits) by $13,000. Is the manager likely to accept the proposal if his bonuses are based on divisional ROI? Would his decision be in the best interests of Telum Ltd?

(3 marks)

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(c) What are the advantages and disadvantages of residual income (RI) compared to return on investment (ROI)? (2 marks)

(d) The Mobile Phone Division has $525,000 of current liabilities, whereas the Tablet Division has only $105,000 of current liabilities. Given a tax rate of 30%, calculate the EVA for each division. (3 marks)

(e) The CEO of Telum Ltd is concerned that the focus on financial measures could have an adverse long-term effect on the viability of the company. Explain how the implementation of a balanced scorecard would help to address his concerns. (3 marks)