Royal Financial Services (RFS) provides front end loan origination services for a number of banks who process and maintain loan portfolios. RFS accepts applications from customers and processes them through closing of the loan agreement before turning the loan over to customer banks. RFS is paid regardless of whether the loan closes or not. RFS currently services three types of loans - residential mortgages, auto loans, and personal unsecured loans. RFS has no cost accounting system so total operating expenses are simply allocated to each product line based on revenue. For the year just ended, RFS reported financial results as follows: Income Statement Mortgage Auto Personal Total Annual Volume of Loans 1500 6000 4000 11500 Origination Fee/Unit $350 $200 $115 Total Revenues $525,000 $1,200,000 $460,000 $ 2,185,000 Operating Expense $504,673 Profit $ 20,327 $1,153,538 $442,189 $ 46,462 $ 17,811 $ 2,100,400 $ 84,600 Profit % Revenue 3.9% 3.9% 3.9% 3.9% RFS management is concerned about the overall low profitability of the business and has asked you to apply activity-based analysis in order to give RFS a better understanding of relative product profitability. After extensive interviewing of staff and analysis of RFS's cost structure, you determine there are four primary activities that RFS performs, with cost drivers and total cost as follows: Mortgag Persona Total Activities Accept Activity Driver e Auto Cost # pages per applications application 1 616,000 Obtain credit # credit sources/ referrals applic. 2 2 1 332,500 Do loan analysis # hours analysis/ applic. 3 2 1 656,000 # hours to close Close loan loan + 2 1 495,900 You determine that the application processing and loan analysis activities are performed using internal RFS resources while the credit and closing activities are performed primarily by external credit agencies and law offices on a per transaction basis (e.g. $X per credit check, $Y per closing hour). You also learn 70% of the mortgages end up being closed (the remainder are not approved after loan analysis); 80% of auto loans close and 90% of personal loans close. You also identify a key external measure of how well RFS is performing versus the industry. While RFS does not bear the cost of defaults, their customers do track RFS performance and use it to negotiate future origination fee rates. Mortgage Auto Personal Default rate experienced by loan processor 2% 1% 6% Industry average 2% 3% 4% Assignment A. Based on the above information, use activity-based costing to assess the total and per unit profitability of RFS's three loan products B. Write a brief memo (maximum 1 page, double spaced, font 12) to RFS management summarizing the results of your analyses. Make specific recommendations to RFS to improve business profitability.