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Case 12-44 Jason Kemp was torn between conflicting emotions. On the one hand, things were going so well. He had just completed six months as the assistant financial manager in the Electronics division of Med-Products Inc. The pay was good, he enjoyed his coworkers, and he felt that he was part of a team that was making a difference in American health care. On the other hand, his latest assignment was causing some sleepless nights. Mel Cravens, his boss, had asked him to \"refine\" the figures on the division's latest projecta portable imaging device codename ZM. The original estimates called for investment of $15.6 million and projected annual income of $1.87 million. Med-Products required a ROI of at least 15% for new project approval. So far, ZM's rate of return was nowhere near that hurdle rate. Mel encouraged him to show increased sales & decreased expenses in order to get the projected income above $2.34 million. Jason asked for a meeting with Mel to voice his concerns. Jason: Mel, I've gone over the figures for the new project and can't find any way to get the income above $1.9 million. The salespeople have given me the most likely revenue figures, and productions feels that the expense figures are solid. Mel: Jason, those figures are just projections. Sales doesn't really know what the revenue will be. In fact, when I talked with Sue Harris, our sales vice president, she said that sales could range from $1.5 million to $2.5 million. Use the higher figure. I'm sure this product will justify our confidence in it! Jason: I know the range of sales was that broad, but Sue felt the $2.5 million estimate was pretty unlikely. She thought that during the first 5 years or so that ZM slaes would stay in the lower end of the range. Mel: Again, Sue doesn't know for sure. She's just estimating. Let's go with the higher estimate. We really need this product to expand our line and to give our division a chance to qualify for sales-based bonuses. If ZM sells at all, our revenue will go up, and we'll all share in the bonus pool! Jason: I don't know, Mel. I feel pretty bad signing off on ROI projections that I have so little confidence in. Mel: (frustrated) Look, Jason, just prepare the report. I'll back you up. Required: 1. What is the ROI of project ZM based on the initial estimates? What would ROI be if the income rose to $2.34 million? 2. Do you agree that Jason has an ethical dilemma? Explain. Is there any way that Mel could ethically justify raising the sales estimates and/or lowering expense estimates? 3. What do you think Jason should do? Explain. Exercise 13-24 Zion Manufacturing had always made its components in-house. However, Bryce Component Works had recently offered to supply one component, K2, at a price of $25 each. Zion uses 10,000 units of Component K2 each year. The cost per unit of this component is as follows: Direct materials $12.00 Direct labor $8.25 Variable overhead $4.50 Fixed overhead $2.00 Total $26.75 The fixed overhead is an allocated expense; none of it would be eliminated if production of Component K2 stopped. Required: 1. What are the alternatives facing Zion Manufacturing with respect to production of Component K2? 2. List the relevant costs for each alternative. If Zion decides to purchase the component from Bryce, by how much will operating income increase or decrease? Which alternative is better? Exercise 13-48 Norton Company produces two products (Juno and Hera) that use the same material input. Juno uses two pounds of the material for every unit produced, and Hera uses five pounds. Currently, Norton has 16,000 pounds of the material in inventory. All of the material is imported. For the coming year, Norton plans to import an additional 8,000 pounds to produce 2,000 units of Juno and 4,000 units of Hera. The unit contribution margin is $30 for Juno and $60 for Hera. Norton Company has received word that the source of the material has been shut down by embargo. Consequently, the company will not be able to import the 8,000 pounds it planned to use in the coming year's production. There is no other source of the material. Required: 1. Compute the total contribution margin that the company would earn if it could manufacture 2,000 units of Juno and 4,000 units of Hera. 2. Determine the optimal usage of the company's inventory of 16,000 pounds of the material. Compute the total contribution margin for the product mix that you recommend. Exercise 13-51 Pamela McDonald, chief management accountant and controller for Murray Manufacturing Inc., was having lunch with Roger Branch, manager of the company's power department. Over the past six months, Pamela and Roger had developed a romantic relationship and were making plans for marriage. To keep company gossip at a minimum, Pamela and Roger had kept the relationship very quiet, and no one in the company was aware of it. The topic of the luncheon conversation centered on a decision concerning the company's power department that Larry Johnson, president of the company, was about to make. Pamela: Roger, in our last executive meeting, we were told that a local utility company offered to supply power and quoted a price per kilowatt-hour that they said would hold for the next three years. They even offered to enter into a contractual agreement with us. Roger: This is news to me. Is the bid price a threat to my area? Can they sell us power cheaper than we make it? And why wasn't I informed about this matter? I should have some input. This burns me. I think I should give Larry a call this afternoon and lodge a strong complaint. Pamela: Calm down, Roger. The last thing I want you to do is call Larry. Larry made us all promise to keep this whole deal quiet until a decision had been made. He did not want you involved because he wanted to make an unbiased decision. You know that the company is struggling somewhat, and they are looking for ways to save money. Roger: Yeah, but at my expense? And at the expense of my department's workers? At my age, I doubt that I could find a job that pays as well and has the same benefits. How much of a threat is this offer? Pamela: Jack Lacy, my assistant controller, prepared an analysis while I was on vacation. It showed that internal production is cheaper than buying, but not by much. Larry asked me to review the findings and submit a final recommendation for next Wednesday's meeting. I've reviewed Jack's analysis, and it's faulty. He overlooked the interactions of your department with other service departments. When these are considered, the analysis is overwhelmingly in favor of purchasing the power. The savings are about $300,000 per year. Roger: If Larry hears that, my department's gone. Pam, you can't let this happen. I'm three years away from having a vested retirement. And my workers they have home mortgages, kids in college, families to support. No, it's not right. Pam, just tell him that your assistant's analysis is on target. He'll never know the difference. Pamela: Roger, what you're suggesting doesn't sound right either. Would it be ethical for me to fail to disclose this information? Roger: Ethical? Do you think it's right to lay off employees that have been loyal, faithful workers simply to fatten the pockets of the owners of this company? The Murrays already are so rich that they don't know what to do with their money. I think that it's even more unethical to penalize me and my workers. Why should we have to bear the consequences of some bad marketing decisions? Anyway, the effects of those decisions are about gone, and the company should be back to normal within a year or so. Pamela: You may be right. Perhaps the well-being of you and your workers is more important than saving $300,000 for the Murrays. Required: 1. Should Pamela have told Roger about the impending decision concerning the power department? What do you think most corporate codes of ethics would say about this? 2. Should Pamela provide Larry with the correct data concerning the power department? Or should she protect its workers? What would you do if you were Pamela? Exercise 14-35 Skiba Company is thinking about two different modifications to its current manufacturing process. The after-tax cash flows associated with the two investments follow: Year Project I Project II 0 $(100,000) $(100,000) 1 -- $63,857 2 $134,560 $63,857 Skiba's cost of capital is 10% Required: 1. Compute the NPV and the IRR for each investment. 2. Explain why the project with the larger NPV is the correct choice for Skiba. Problem 14-39 Ondi Airlines is interested in acquiring a new aircraft to service a new route. The route will be from Tulsa to Denver. The aircraft will fly one round-trip daily except for scheduled maintenance days. There are 15 maintenance days scheduled each year. The seating capacity of the aircraft is 150. Flights are expected to be fully booked. The average revenue per flight (one way) is $235. Annual operating cost of the aircraft follow: Fuel -- $1, 750,000 Flight personnel -- $750,000 Food and beverages -- $100,000 Maintenance -- $550,000 Other -- $100,000 Total $3,250,000 The aircraft will cost $120,000,000 and has an expected life of 20 years. The company requires a 12% return. Assume there are no income taxes. Required: 1. Calculate the NPV for the aircraft. Should the company buy it? 2. In discussing the proposal, the marketing manager for the airline believes that the assumption of 100 percent booking is unrealistic. He believes that the booking rate will be somewhere between 70 & 90 percent, with the most likely rate being 80 percent. Recalculate the NPV using an 80 percent seating capacity. Should the aircraft be purchased? 3. Calculate the average seating rate that would be needed so that NPV will equal 0. 4. Suppose that the price per passenger could be increased by 10 percent without any effect on demand. What is the average seating rate now needed to achieve a NPV equal to zero? What would you now recommend
