This question consists of two parts: Part A and B. You are required to answer both parts.

Timber Products Inc.(TPI) is a market leader in the supply of timber wood to the furniture manufacturing industry. The company has two divisions. TPIs Timberland division manages forest land and sells timber wood as raw materials to furniture manufacturers. The other division - Manufacturing division - manufactures a range of panel products used to manufacture furniture.

The following information is available for the three-year period:

(1) (i) Net Assets as at 31 December were as follows:

Note: No disposal of fixed assets took place during the above periods.

(ii) The total capital employed by TPI was invested in the divisions during each year as follows:

(iii) Depreciation is charged at 10% per annum on an accelerated basis.

(iv) Depreciation is the only non-cash expense.

(2) Operating cash flows were as follows:

(3) Each division has a target rate of return of 20% on average capital employed each year. Divisional managers are eligible to receive an annual bonus amounting to 30% of annual salary if the target rate of return is achieved.

Part A

Required:

(a) Compute the return on the average capital employed for each of the divisions (rounded to one decimal place of a percentage) for the years ended 31 December 20X5 and 31 December 20X6.(10 marks)

(b) Comment on how each divisional manager might respond to the results achieved in Part A (a). Advise TPI on any potential problems that could result. (8 marks)

Part B

Until 31 December 20X6, TPI outsourced its entire sales administration function. Sales administration service costs amounting to $2,200,000 and $6,800,000 would have been incurred by Timberland and Manufacturing divisions respectively, during the year ending 31 December 20X7. However, a strategic decision was taken to establish an in- house sales administration division, known as the Admin division, dedicated to servicing the needs of divisions Timberland and Manufacturing. The Admin division became operational on 1 January 20X7, and would not provide any service whatsoever to external parties.

(1) Budgeted information with respect to the year ending 31 December 20X7 is as follows:

(2) The management accountant has prepared a detailed analysis of the budget of the Admin division for the year ending 31 December 20X7 which is as follows:

(3) The estimated usage of the Admin division by the Timberland and Manufacturing divisions is as follows:

(4) TPI owns tree plantations from which it satisfies 100% of its requirement for year.

The managing director of TPI has proposed that all services provided by the Admin division to the Timberland and Manufacturing divisions during the year ending 31 December 20X7 be invoiced on the basis of all costs plus 20%. Management costs would be shared equally between the Timberland and Manufacturing divisions. All other costs would be split according to the estimated usage data detailed in note (3) above.

Required:

Evaluate the managing directors proposal. Include in your evaluation the likely acceptance of the decision to outsource, as well as the managing directors proposal on pricing, by the three division managers. Support your answer with relevant computations. (22 marks)

Fixed Assets (net book value) Net Current Assets Net Assets Fixed Assets acquired at beginning of year 20X6 $'000 75,600 64,400 140,000 19,200 20X5 $'000 64,800 55,200 120,000 18,000 20X4 $'000 54,000 56,000 110,000 Division Timberland Manufacturing % of total capital employed 30 70 Division 20X6 $million 14.4 20 20X5 $million 13.1 Timberland Manufacturing 18 Division Timberland $million 39 10 Manufacturing $million 91 16 Admin $million 6.5 Average capital employed Profit before admin costs Total $'000 4,100 900 Order Processing $'000 2,900 400 Invoice Generation $'000 450 450 Management Costs $'000 750 50 Salaries Consumable items IT costs Sundry operating costs Total 1,000 1,000 600 300 100 400 300 300 7,000 4,200 1,400 1,400 Cost driver Activity volume Sales orders 870,000 Invoices 700,000 Division Number of orders processed Number of invoices generated Timberland 217,500 140,000 Manufacturing 652,500 560,000