Unit 10 Study Exercises

Question 10.1

(Total: 33 marks)

Sleepy Owl Company allows its divisions to operate as autonomous units. Their results for the current year were as follows:

	Pillow	Blanket	Bed Sheet
Revenues	$2,250,000	$500,000	$4,800,000
Current assets	800,000	152,500	1,435,000
Capital assets	1,000,000	400,000	1,750,000
Current liabilities	350,000	75,000	540,000
Net operating income	220,000	60,000	480,000
After-tax income	143,000	39,000	312,000
Weighted average cost of capital	8.5%	8.5%	8.5%

Required:

1. Return on sales
2. Return on investment based on total assets employed
3. Economic value added
4. Residual income based on net operating income

Question 10.2

(Total: 18 marks)

Provide the missing data for the following situations:

	Red Division	White Division	Green Division
Sales	A	$10,000,000	E
Net operating income	$240,000	$500,000	$288,000
Total assets	B	C	$1,600,000
Return on investment	0.16	0.10	F
Return on sales	0.05	D	0.14

(3 marks each)

Question 10.3

(Total: 15 marks)

A multinational corporation established a division in Germany as a subsidiary corporation, with an initial investment in total assets of 13 million 's, which cost the company $19,240,000 Canadian at the time. The company sent an experienced manager to run the division, and gave her a target of 12% required rate of return, promising a bonus if this was met and/or exceeded.

After one year, the subsidiary manager was pleased to report an 18% ROI.

You have been able to determine the following data pertaining to the subsidiary:

• Exchange rate at end of year was $1.42 Canadian to the Euro
• Operating income was earned evenly throughout the year
• The exchange rate changed approximately evenly throughout the year

Required:

1. Calculate the subsidiary's income in 's. (3 marks)
2. Calculate the subsidiary's return on investment in Canadian dollars. (6 marks)
3. Calculate the subsidiary's residual income in Canadian dollars. (6 marks)

Question 10.4

(Total: 34 marks)

Big Machines Corp. has two divisions. Division Y manufactures components that can be sold in the external market place or transferred to Division Z for further processing. The following data relate to Division Y's component product.

Variable manufacturing costs/unit	$925
Fixed costs/unit at capacity	$275
Selling price/unit	$1,800

The capacity of the plant is 2,500 units per year.

Division Z has offered to purchase 350 units from Division Y at a price of $1,600/unit, which is the market price of the component. The manager of Division Y has refused this offer stating that it would only return a rate of 25.00%, when the divisional target return on sales is 28.00%. The Division Y manager also states that additional fixed costs of $195,000 would be required to produce the 350 units.

The corporate required rate of return is 18% of assets and the existing asset base in Division Y is $2,500,000.

Required:

1. How many units must Division Y sell in order to achieve its required ROR? What profit margin would be earned at this level of sales?
2. (8 marks)

1. Assume Division Y currently sells 2,000 units to the external market and can accept Division Z's offer without affecting its external sales. Evaluate the refusal of Division Z's offer from the standpoint of the corporation as a whole and from Division Y manager's perspective.
2. (18 marks)

1. Assume Division Y currently sells 2,000 units to the external market and can accept Division Z's offer without affecting its external sales. Calculate Division Y's residual income with and without the sale to Division Z.
2. (8 marks)