How to Calculate Singapore Company Corporate Tax

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					Question 18-1 through 18-13
  18-1 Explain the advantages of investment SBUs. Why would a firm choose investment SBU
  rather than profit SBU or cost SBU evaluation?




 18-2 What are the three investment SBU evaluation measures?




 18-3 What is return on investment, and how is it calculated?




  18-4 What are the measurement issues to consider when using return on investment?
18-5 What are the advantages and limitations of return on investment?




18-6 What is meant by the arm’s-length standard, and for what is it used?




18-7 What are the components of return on investment, and how is each interpreted and use
 18-8 What are the advantages and limitations of residual income?




18-9 What are the objectives of investment SBU evaluation?




18-10 What is return on equity, how is it calculated, and how is it interpreted?
 18-11 What are the three methods most commonly used in international taxation to determi
 price acceptable to tax authorities? Explain each method briefly.




18-12 What does expropriation mean, and what is the role of transfer pricing in this regard?




 18-13 How does the concept of economic value added compare to return on investment
firm choose investment SBU evaluation




?




eturn on investment?
estment?




at is it used?




is each interpreted and used?
?




interpreted?
 ational taxation to determine a transfer
efly.




fer pricing in this regard?




e to return on investment and residual income?
Brief Exercises 18-14 through 18-25
  18-14 Smith Branded Apparel designs t-shirts for businesses and corporations. The ac
  presented the latest quarter return on sales data of 10 percent and asset turnover of 1.
  the company’s current return on investment?




  18-15 Williams Manufacturing uses scrap metal to produce various tools, such as drill
  heads, saw blades, and nails. The CEO has asked you to analyze the saw blades division
  asset turnover for last quarter. You find that the saw blades division had an ROI of 20
  $10 million and profits of $1 million. What was the asset turnover rate for last quarter




 18-16 Scott Healthcare provides a walk-in clinic for its patients and a pharmacy for any
 prescribed by the doctor. Its primary asset is the medication for patients. Last year Sco
 sales of $500,000 and $100,000 in profits. Scott also had average assets of $250,000 for t
 Scott Healthcare’s return on sales, asset turnover, and return on investment?
18-17 Matthews Produce harvests and sells Florida oranges. Matthews has hired you to
return on investment based on net book value and gross book value. You are given that
million, the net book value (NBV) of the machinery is $10 million, and the gross book va
machinery is $40 million. What is ROI based on NBV and GBV?




18-18 Foreman Publishing Company’s income for the most recent quarter was $500,000, an
value of assets was $1.5 million at the end of the quarter. If the company has a required rate
of 15 percent on investments, what was residual income for the quarter?




18-19 Tinsley Plastics manufactures plastic bottles used for beverages and household cleane
book value of assets at the end of this quarter is $500,000. If the required rate of return is 10
on assets, and the firm wants to have residual income of $100,000 for this quarter, what mus
be?
18-19 Tinsley Plastics manufactures plastic bottles used for beverages and household cleane
book value of assets at the end of this quarter is $500,000. If the required rate of return is 10
on assets, and the firm wants to have residual income of $100,000 for this quarter, what mus
be?




18-20 Moore Money is a financial services firm specializing in fixed income investments
asked by the accounting manager to analyze the company’s financial data from last qu
they had return on investment of 15 percent and asset turnover of 0.5. What was their r




18-21 King Mattresses sells both mattress sets and bed frames. Last quarter total sales
for mattress sets and $25,000 for bed frames. ROI was 10 percent for both divisions, an
turnover was 5 for mattress sets and 2 for bed frames. What were profits for each divis
  18-22 Using the data from 18-21 above, compute King Mattresses’ total return on sal




18-23 Felton Co. produces rubber bands for commercial and home use. Felton reported
income with $20 million net book value of assets and $5 million in income for the year.
the required rate of return?




18-24 Chacon Enterprises manufactures energy-efficient glass for commercial and resi
year Chacon reported sales of $10 million, profits of $2 million, and asset turnover of 2
return on investment?




 18-25 Cano Inc. sells retail apparel. You have been asked to compute ROI using avera
 quarter. Profits were $50,000, beginning of year assets were $150,000, and end of year
 $190,000. What was ROI?
18-25 Cano Inc. sells retail apparel. You have been asked to compute ROI using avera
quarter. Profits were $50,000, beginning of year assets were $150,000, and end of year
$190,000. What was ROI?
 and corporations. The accounting manager has
nt and asset turnover of 1.5. What is




 arious tools, such as drill bits, hammer
 yze the saw blades division to determine
 division had an ROI of 20 percent, sales of
nover rate for last quarter?




ts and a pharmacy for any medication
or patients. Last year Scott recorded total
ge assets of $250,000 for the year. What are
 on investment?
Matthews has hired you to determine its
 value. You are given that profits are $2
lion, and the gross book value (GBV) of the
 V?




 t quarter was $500,000, and the net book
ompany has a required rate of return
uarter?




rages and household cleaners. The net
required rate of return is 10 percent
0 for this quarter, what must their profits
rages and household cleaners. The net
required rate of return is 10 percent
0 for this quarter, what must their profits




n fixed income investments. You have been
 nancial data from last quarter. You find
 er of 0.5. What was their return on sales?




 s. Last quarter total sales were $50,000
rcent for both divisions, and asset
 were profits for each division?
tresses’ total return on sales.




 home use. Felton reported $1 million residual
on in income for the year. What was




s for commercial and residential use. Last
n, and asset turnover of 2. What is Chacon’s




 compute ROI using average assets for last
 $150,000, and end of year assets were
compute ROI using average assets for last
$150,000, and end of year assets were
    Required

    At which phases of the sales life cycle, if any, should investment SBU evaluation methods be used,
    why?


Solution
Solution
  18-28 Requirements

ROI, which division is more successful? Why?
 es residual income as a measure of management success. What is the residual
 ch division if the minimum desired rate of return is (a) 10 percent, (b) 15 percent, (c) 20 percent?
n is more successful under each of these rates?
16-43 (Continued)
   Placement Success (weight = 35%):
         Mean Starting Salary and Bonus (14%)--The average starting salary and bonus of 2005
          graduates of a full-time master's program in business. Salary figures are based on the
          number of graduates that reported data. The mean signing bonus is weighted by the
          proportion of those graduates that reported a bonus, since not everyone who reported a base
          salary figure reported a signing bonus.
         Employment Rates for Full-time Master's Program in Business Graduates (11%)--The
          employment rate for 2005 graduates of a full-time master's program in business. Those not
          seeking jobs or for whom no job-seeking information is available are excluded. If the
          proportions of graduates for whom no job-seeking information is available and who are not
          seeking jobs are high, then the information is not used in calculating the rankings.
          Employment rates at graduation (0.07) and three months after graduation (0.14) are used in
          the ranking model.
   Student Selectivity (weight = 25%):
         Mean GMAT Scores (16.25%)--The average Graduate Management Admission Test score
          of students entering the full-time program in fall 2005. Scores on the test range from 200 to
          800.
         Mean Undergraduate GPA (7.5%)--The average undergraduate grade-point average of
          those students entering the full-time program in Fall 2005.
         Acceptance Rate (1.25%)--The percent of applicants to the full-time program in fall 2005
          who were accepted.
   Overall Program Rank: Data were standardized about their means, and standardized scores were
   weighted, totaled, and rescaled so that the top school received a score of 100; others received their
   percentage of the top score.
Source: U.S. News & World Report, April 10, 2006 (or, http://www.usnews. com/
usnews/edu/grad/rankings/about/07biz_meth_brief.php, accessed on April 4, 2006).
2. Calculate the residual income for each of the SBUs.
3. Calculate EVA ® for each of the SBUs

Solution
           18-31 Requirements

1. Calculate the return on investment for each of the divisions.
2. Calculate the residual income for each of the divisions.
3. Gordon has estimated the amount of intangibles that are not recorded on the firm’s accounting statements
using generally accepted accounting principles and has included that additional information above. Assume
that adjusting net income for the unrecorded intangibles would increase net income of the Eastern,
Central, and Western divisions by $22,000, $15,000, and $1,500, respectively, after tax. Determine the
EVA ® for each division.
4. Compare and interpret the differences between your answers in parts 1, 2, and 3.


Solution
Division B’s capacity utilization                                                  100%


18-32 Requirements

1. Will the company benefit if division A purchases outside the company? Assume that division B cannot
sell its materials to outside buyers.
2. Assume that division B can save $200,000 in fixed costs if it does not manufacture the material for division
A. Should division A purchase from the outside market?
3. Assume the situation in requirement 1. If the outside market value for the materials drops $20, should
A buy from the outside?

Solution
                                 Problem Information


Outside price for materials                                  $150
Division A’s annual purchases                               10,000 units
Division B’s variable costs per unit                         $140
Division B’s variable costs per unit                           $8
Division B’s per unit                                        $210
Division B’s fixed costs                               $1,250,000
Division B’s capacity utilization                            100%


Solution
 Preferred Products, a bicycle manufacturer, uses normal volume as the basis for setting
 prices. That is, it sets prices on the basis of long-term volume predictions and then adjusts
 them only for large changes in pay rates or material prices. You are given the following
 information:

Problem Information

Materials, wages, and other variable costs                $300 per unit
Fixed costs                                           $200,000 per year
Target return on investment                                20%
Normal volume                                             1,500
Investment (total assets)                             $800,000

18-34 Requirements

1. What sales price is needed to attain the 20 percent target ROI?
2. What ROI rate will be earned at sales volumes of 2,000 and 1,000 units, respectively, given the sales
price determined in requirement 1?


Solution
Solution
18-36 Requirements
18-37 Requirements
Determine the economic profit per employee, productivity per employee, and personnel costs per employee.

Solution
Problem 18-39 Calculating ROI & RI And Comparing Results
            Background
Blackwood Industries manufactures die machinery. To meet its expansion needs, it re
acquired one of its suppliers, Delta Steel. To maintain Delta’s separate identity, Black
operations as an investment SBU. Blackwood monitors all of its investment SBUs on
on investment. Management bonuses are based on ROI, and all investment SBUs are
10 percent minimum before income taxes.
Delta’s ROI has ranged from 14 percent to 18 percent since 2005. The company rece
opportunity for a new investment that would have yielded 13 percent ROI. However, d
decided against the investment because it believed that the investment would decrea
overall ROI.
The 2007 operating statement for Delta follows. The division’s operating assets were
end of 2007, a 5 percent increase over the 2006 year-end balance.

        Problem Information

                 DELTA DIVISION
        Operating Statement For Year Ended
         December 31, 2007 (000s omitted)
Sales                                   $25,000
Cost of goods sold                         16,600
Gross profit                                8,400
Operating expense
Administration               $2,340
Selling                        3,610        5,950
Income before income taxes                $2,450


        18-39 Requirements

1. Calculate the following performance measures for 2007 for the Delta division:
a. Return on average investment in operating assets employed.
b. RI calculated on the basis of average operating assets employed.
2. Which performance measure (ROI or RI) should Blackwood Industries use to provide th
for each division to act autonomously in the firm’s best interests? 3. Would Delta’s manag
been more likely to accept the capital investment opportunity if RI had been used as a per
measure instead of ROI? Explain.
3. What type of strategic performance measurement do you recommend for Vienna Divisio

Solution
pansion needs, it recently (2005)
 rate identity, Blackwood reports Delta’s
 estment SBUs on the basis of return
 vestment SBUs are expected to earn a

The company recently had the
nt ROI. However, division management
ment would decrease the division’s

 ating assets were $15,000,000 at the




a division:


es use to provide the proper incentive
ould Delta’s management have
been used as a performance
nd for Vienna Division? Explain.
Problem 18-40 Transfer Pricing; Decision Making
                              Background
  Phoenix Inc., a cellular communication company, has multiple divisions. Each division’s
  compensated based on the division’s operating income.
  Division A currently purchases cellular equipment from outside markets and uses it to pr
  communication systems. Division B produces similar cellular equipment that it sells to ou
  but not to division A at this time. Division A’s manager approaches division B’s manager
  to buy the equipment from division B. If it produces the cellular equipment that division A
  division B would incur variable manufacturing costs of $60 per unit.

                          Problem Information

Relevant Information about Division B
Sells units of equipment to outside customers                      50,000
Price per unit                                                       $130
Operating capacity is currently                                      80%
The division can perform at                                         100%
Variable manufacturing costs are                                     $70
Variable marketing costs are                                          $8
Fixed manufacturing costs are                                   $580,000
Variable manufacturing costs if manufacured for Div A                $60

Income per Unit for Division A (assuming parts purchased outside, not from division
Sales revenue                                                $320
Manufacturing costs
Cellular equipment                                              80
Other materials                                                 10
Fixed costs                                                     40
Total manufacturing costs                                      130
Gross margin                                                 $190
Marketing costs
Variable                                                        35
Fixed                                                           15
Total marketing costs                                           50
Operating income                                             $140

                          18-40 Requirements
1. Division A wants to buy all 25,000 units from division B at $75 per unit. Should division
reject the proposal? How would your answer differ if (a) Division A requires all 25,000 unit
to be shipped by the same supplier, or (b) Division A would accept partial shipment from D
2. What range will the managers of divisions A and B agree is the best price for each divis

Solution
divisions. Each division’s management is

 markets and uses it to produce
quipment that it sells to outside customers
hes division B’s manager with a proposal
 equipment that division A desires,
unit.




          percent
          percent
           per unit.
          per unit.



utside, not from division B)
per unit. Should division B accept or
A requires all 25,000 units in the order
pt partial shipment from Division B?
e best price for each division?
Problem 18-41 Return on Investment; Residual Income
                     Background

  Raddington Industries is a diversified manufacturer with several divisions, including the
  Division. Raddington monitors its divisions on the basis of both unit contribution and retu
  investment (ROI), with investment defined as average operating assets employed. All in
  operating assets are expected to earn a minimum return of 9 percent before income tax
  Reigis’s cost of goods sold is considered to be entirely variable; its administrative expen
  depend on volume. Selling expenses are a mixed cost with 40 percent attributed to sale
  The 2007 operating statement for Reigis follows. The division’s operating assets employ
  $80,750,000 at November 30, 2007, unchanged from the year before.
Operating Assets=                     $     80,750,000

                Problem Information

                     REIGIS STEEL DIVISION
                       Operating Statement
              For the Year Ended November 30, 2007
                          (000s omitted)
Sales revenue                                                   $35,000
Less expenses
Cost of goods sold                       $18,500
Administrative expenses                     3,955
Selling expenses                            2,700                 25,155
Income from operations before tax                                $9,845


                 18-41 Requirements

1. Calculate Reigis Steel Division’s unit contribution if it produced and sold 1,484,000 units
ended November 30, 2007.
2. Calculate the following performance measures for 2007 for Reigis:
a. Pretax ROI from average operating assets employed.
b. Residual income calculated on the basis of average operating assets employed.
3. Reigis management is presented the opportunity to invest in a project that would earn a
Is Reigis likely to accept the project? Why or why not?
4. Identify several items that Reigis should control if it is to be fairly evaluated as a separa
SBU within Raddington Industries using either ROI or RI performance measures.
(CMA Adapted)

Solution
me


everal divisions, including the Reigis
 both unit contribution and return on
 rating assets employed. All investments in
 f 9 percent before income taxes.
 iable; its administrative expenses do not
h 40 percent attributed to sales volume.
 ion’s operating assets employed were
year before.




uced and sold 1,484,000 units during the year



ting assets employed.
in a project that would earn an ROI of 10 percent.

e fairly evaluated as a separate investment
 ormance measures.
Problem 18-42 Performance Evaluation
                        Background
Darmen Corporation is one of the major producers of prefabricated homes in the home bu
The corporation consists of two divisions: (1) Bell Division, which acquires the raw materi
manufacture the basic house components and assembles them into kits, and (2) Cornish
takes the kits and constructs the homes for final home buyers. The corporation is decentr
management of each division is measured by its income and return on investment. Bell D
assembles seven separate home kits using raw materials purchased at the prevailing ma
seven kits are sold to Cornish for prices ranging from $45,000 to $98,000.

The prices are set by corporate management of Darmen using prices paid by Cornish wh
comparable units from outside sources. The smaller kits with the lower prices have becom
portion of the units sold because the final home buyer is faced with prices which are incre
rapidly than personal income. The kits are manufactured and assembled in a new plant ju
by Bell this year. The division had been located in a leased plant for the past four years.
All kits are assembled upon receipt of an order from Cornish Division. When the kit is co
assembled, it is loaded immediately on a Cornish truck. Thus, Bell Division has no finish
The Bell Division’s accounts and reports are prepared on an actual cost basis. There is
product standards have been developed. A factory overhead rate is calculated at the be
year. The rate is designed to charge all overhead to the product each year. Any under-
overhead is allocated to the cost of goods sold account and work in process inventories

Bell Division’s performance report follows. This report forms the basis of the evaluation
its management by the corporate CFO. Additional information regarding corporate and d
as follows:

The corporate office does all the personnel and accounting work for each division. The
costs are allocated on the basis of number of employees in the division. The corporate a
allocated to the division on the basis of total costs excluding corporate charges. The div
costs are included in factory overhead. The financing charges include a corporate impu
on division assets and any divisional lease payments. The division investment for the re
calculation includes division inventory and plant and equipment at gross book value.



                   Problem Information

                                              BELL DIVISION
                                            Performance Report
                                 For the Year Ended December 31, 2007


                                                 2007         2006
Summary data
Net income ($000 omitted)                      $34,222      $31,573
Return on investment                             37%          43%
Production data (in units)
Kits started                                     2,400        1,600
Kits shipped                                     2,000        2,100
Kits in process at year-end                       700          300
Financial data ($000 omitted)
Sales                                          $138,000     $162,800
Production costs of units sold
Raw material                                   $32,000      $40,000
Labor                                           41,700       53,000
Factory overhead                                29,000       37,000
Cost of units sold                             $102,700     $130,000
Other costs
Corporate charges for
Personnel services                               $228         $210
Accounting services                               425          440
Financing costs                                   300          525
Total other costs                                $953        $1,175
Adjustments to income
Unreimbursed fire loss                            —           $52
Raw material losses due to improper storage      $125          —
Total adjustments                                $125         $52
Total deductions                               $103,778     $131,227
Division income                                $34,222      $31,573
Division Investment                            $92,000      $73,000
Return on Investment                             37%          43%


                   18-42 Requirements

1. What performance evaluation system does Darmen Corporation use? Discuss the value
evaluating the Bell Division and its management.
2. Present specific recommendations to the management of Darmen Corporation to impro
evaluation system.
(CMA adapted)

Solution
 homes in the home building industry.
cquires the raw materials to
o kits, and (2) Cornish Division, which
 corporation is decentralized and the
 on investment. Bell Division
ed at the prevailing market prices. The
98,000.

es paid by Cornish when it buys
wer prices have become a large
 prices which are increasing more
mbled in a new plant just purchased
r the past four years.
 ion. When the kit is completely
l Division has no finished goods inventory.
al cost basis. There is no budget and no
 is calculated at the beginning of each
ach year. Any under- or over-applied
in process inventories.

asis of the evaluation of the division and
arding corporate and division practices is


or each division. The corporate personnel
vision. The corporate accounting costs are
orate charges. The division administration
 ude a corporate imputed interest charge
n investment for the return on investment
  gross book value.
31, 2007
              Increase or (Decrease)
                    from 2006
            Amount      Percent Change

             $2,649            0.08


              800             50.00
              (100)            4.80
              400             133.30

            ($24,800)         (15.20)

             ($8,000)         (20.00)
             (11,300)         (21.30)
              (8,000)         (21.60)
            ($27,300)         (21.00)


              $18               8.60
               (15)            (3.40)
              (225)           (42.90)
             ($222)           (18.90)

              ($52)           (100.00)
              $125               —
              $73              140.40
            ($27,449)          (20.90)
             $2,649             8.40
            $19,000            26.00




use? Discuss the value of the system in
n Corporation to improve its performance
Problem 18-43 Performance Evaluation; Strategy Map; Review of Chapter 17; C
     Background

Maydew Manufacturing Inc. is a large manufacturer of lawn and garden equipment inc
tillers, related equipment, and accessories. The firm has been very successful in rece
have grown more than 10 percent in each of the last five years. The firm is organized
SBUs based on product line groups. Return on investment and residual income calcu
for each of the last four years and used in management compensation for the last two
Maydew top management has contracted with MM&PC, a large consulting firm to revi
measurement process at the firm. One of MM&PC’s key recommendations has been
implementation of the balanced scorecard both for performance measurement and fo
As a step in this direction, MM&PC has asked Maydew for some data on ROI and oth
considered for the balanced scorecard to analyze the relationships among these data
analysis will help MM&PC develop a strategy map for the firm. The following data sho
each SBU and the average for the last three years for training hours per employee in
retention rate in the SBU (customers are primarily large department store chains and
lawn and garden equipment), the QSV score, and the defect rate (per thousand produ
a measure of the Quality-Service-Value of the SBU made by an analysis of a variety o
including the results of on-site inspection of each unit by key operating executives and
operating performance (the highest score is 10, and the lowest is 0).


 Problem Information


                          Training Hours      Customer        QSV
 Manager         ROI      per Employee        Retention      Score
    1            21.3            98              99.3          7
    2            15.4           122              98.2          8
    3             9.6            67              86.7          6
    4            12.4            88              84.5          9
    5            18.6            92              91.4          8
    6             4.5            33              90.7          4
    7             8.8            49              88.9          6
    8            22.6            77              93.5          10
    9            11.8           102              95.5          9
   10            14.6            95              91.1          6
   11            16.5            87              92.7          6
   12            12.1            80              86.4          8
     13           6.2              66               80.2           4
     14           1.3              50                78            4
     15           9.7              78               85.5           7


  18-43 Requirements

1. Using the concept of the strategy map, consider how the nonfinancial factors (training h
retention, QSV, and defect rate) affect ROI. Which of these variables has the greatest influ
2. Use regression and correlation analysis to perform your analysis.
Explain which two managers you would rate as the best overall and which you would rate
overall, and give reasons why.

Solution
Using this approach, and assuming that QSV and customer retention are useful predictor
ROI, managers 1, 5 and 11 produced ROIs somewhat higher than would have been expec
QSV and customer retention scores. What have these managers done beyond the QSV a
retention to improve ROI? In contrast, managers 6 and 9 have relatively low ROI given t
retention and QSV scores. What factors are missing to explain this.
Review of Chapter 17; Correlation Analysis

 and garden equipment including mowers, edgers,
en very successful in recent years, and sales
ars. The firm is organized into 15 investment
 nd residual income calculations have been made
 pensation for the last two years. Recently
 rge consulting firm to review the performance
ommendations has been to consider the
 nce measurement and for strategic management.
 ome data on ROI and other measures being
 nships among these data. It is hoped that the
m. The following data show the last year’s ROI for
 g hours per employee in the SBU, customer
artment store chains and other distributors of
  rate (per thousand products). The QSV score is
  an analysis of a variety of operating data
  operating executives and other measures of
est is 0).




            Defect
             Rate
              3.3
              4.7
             11.2
             13.7
              2.1
             28.9
              1.2
             12.4
               8
              7.4
              2.8
              4.9
             15.3
             22.8
             30.5




financial factors (training hours, customer
ables has the greatest influence on ROI?

and which you would rate as the worst
 ention are useful predictors of
 an would have been expected given their
 rs done beyond the QSV and customer
e relatively low ROI given their customer
Problem 18-44 Transfer Pricing Methods

  Lynsar Corporation started as a single plant to produce its major components and t
  product into electric motors. Lynsar later expanded by developing outside markets f
  in its motors. Eventually, the company reorganized into four manufacturing divisions
  and motor. Each manufacturing division operates as an autonomous unit, and divis
  basis for year-end bonuses. Lynsar’s transfer pricing policy permits the manufactur
  externally or internally. The price for goods transferred between divisions is negotia
  selling divisions without any interference from top management. Lynsar’s profits for
  dropped although sales have increased, and the decreased profits can be traced al
  division. Jere Feldon, Lynsar’s chief financial officer, has learned that the motor divi
  its motors from an outside supplier during the current year rather than buying them
  which is at capacity and has refused to sell to the motor division. It can sell them to
  price higher than the actual full (absorption) manufacturing cost that has always bee
  with the motor division. When the motor division refused to meet the price that the s
  from its outside buyer, the motor division had to purchase the switches from an outs
  higher price. Jere is reviewing Lynsar’s transfer pricing policy because he believes
  occurred. Although the switch division made the correct decision to maximize its div
  transferring the switches at actual full manufacturing cost, this was not necessarily i
  because of the price the motor division paid for them. The motor division has alway
  division and has tended to dominate the smaller divisions. Jere has learned that the
  divisions are also resisting the motor division’s expectation to use the actual full ma
  negotiated price. Jere has requested that the corporate accounting department stu
  pricing methods to promote overall goal congruence, motivate divisional manageme
  optimize overall company performance. Three transfer pricing methods being consi
  The one selected will be applied uniformly across all divisions. Standard full manuf
  Market selling price of the products being transferred. Outlay (out-of-pocket) costs
  transfer plus opportunity cost to the seller, per unit.
  Required
  1. Discuss the following:
  a. The positive and negative motivational implications of employing a negotiated tra
  goods exchange between divisions.
  b. The motivational problems that can result from using actual full (absorption) man
  transfer price.
  2. Discuss the motivational issues that could arise if Lynsar Corporation decides to
  policy of covering the transfer of goods between divisions to a revised transfer pricin
  uniformly to all divisions.
  3. Discuss the likely behavior of both buying and selling divisional managers for eac
  listed earlier, if it were adopted by Lynsar.
  (CMA Adapted)
Solution
 jor components and then assembled its main
 ping outside markets for some components used
manufacturing divisions: bearing, casing, switch,
 omous unit, and divisional performance is the
 ermits the manufacturing divisions to sell either
en divisions is negotiated between the buying and
 nt. Lynsar’s profits for the current year have
 rofits can be traced almost entirely to the motor
ned that the motor division purchased switches for
 her than buying them from the switch division,
 on. It can sell them to outside customers at a
 st that has always been negotiated in the past
 eet the price that the switch division was receiving
  switches from an outside supplier at an even
  because he believes that suboptimization has
  on to maximize its division profit by not
   was not necessarily in Lynsar’s best interest
 tor division has always been Lynsar’s largest
 e has learned that the casing and bearing
 use the actual full manufacturing cost as the
 unting department study alternative transfer
   divisional management performance, and
   methods being considered follow.
 . Standard full manufacturing costs plus markup.
  (out-of-pocket) costs incurred to the point of



 oying a negotiated transfer price system for

  full (absorption) manufacturing costs as a

 orporation decides to change from its current
  revised transfer pricing policy that would apply

 onal managers for each transfer pricing method
Problem 18-45 Transfer Pricing Issues

  Often when transfer prices are based on cost, a supplying division has no incentive to re
  For example, a design change that would reduce the supplying division’s manufacturing
  benefit only downstream divisions if the transfer price is based on a markup of cost.
  Required
  What can or should be done to provide the supplying division an incentive to reduce ma
  costs when the transfer price is cost-based?



Solution
  has no incentive to reduce cost.
vision’s manufacturing cost would
 a markup of cost.


ncentive to reduce manufacturing
Problem 18-46 Transfer Pricing; International Taxation
           Background

Harris Company has a manufacturing subsidiary in Singapore that produces high-end
exercise equipment for U.S. consumers. The manufacturing subsidiary has total
manufacturing costs of $1,500,000 plus general and administrative expenses of $350,00
The manufacturing unit sells the equipment for $2,500,000 to the U.S. marketing
subsidiary, which sells it to the final consumer for an aggregate of $3,500,000. The sales
subsidiary has total marketing, general, and administrative costs of $200,000. Assume
that Singapore has a corporate tax rate of 33 percent and that the U.S. tax rate is 46
percent. Assume that no tax treaties or other special tax treatments apply.



       Problem Information


Manufacturing subsidiary total manufacturing costs       $1,500,000
Plus general and administrative expenses of               $350,000
The manufacturing unit sells the equipment for           $2,500,000
U.S. marketing subsidiary, sells it for                  $3,500,000
The sales subsidiary has total marketing, general,
and administrative costs                                  $200,000
Singapore corporate tax rate                                33%
U.S. tax rate                                               46%

       18-46 Requirements

What is the effect on Harris Company’s total corporate level taxes if the manufacturing sub
raises its price by 20 percent to the sales subsidiary?

Solution
e that produces high-end
subsidiary has total
 trative expenses of $350,000.
o the U.S. marketing
ate of $3,500,000. The sales
osts of $200,000. Assume
at the U.S. tax rate is 46
 tments apply.




axes if the manufacturing subsidiary
Problem 18-47 Transfer Pricing; Decision Making
                                Background

Advanced Manufacturing Inc. (AMI) produces electronic components in three divisions: in
commercial, and consumer products. The commercial products division annually purchase
units of part 23–6711, which the industrial division produces for use in manufacturing one
products. The commercial division is growing rapidly due to rapid growth in its markets. Th
commercial division is expanding its production and now wants to increase its purchases
6711 to 15,000 units per year. The problem is that the industrial division is at full capacity.
investment in the industrial division has been made for some years because top managem
little future growth in its products, so its capacity is unlikely to increase soon.
The commercial division can buy part 23–6711 from HighTech Inc. or from Britton Electric
of the industrial division, now purchasing 650 units of part 88–461. The industrial division’
Britton would not be affected by the commercial division’s decision about part 23–6711.


                           Problem Information

Industrial division
Data on part 23–6711
     Price to commercial division                                   $185
     Variable manufacturing costs                                   155
     Price to outside buyers                                        205
Data on part 88–461
     Variable manufacturing costs                                   65
     Sales price                                                    95
Other suppliers of part 23–6711
     HighTech Inc., price                                           200
     Britton Electric, price                                        210

Additional Units to be Purchased                                   5,000
Parts Purchased from Britton                                        650

                            18-47 Requirements

1. What is the proper decision regarding where the commercial division should purchase t
5,000 parts and what is the correct transfer price?
2. Assume that the industrial division’s sales to Britton would be cancelled if the commerci
not buy from Britton. What would be the unit cost to AMI in this case, and would the desire
price change?
3. What are the strategic implications of your answer to requirement 1? How can AMI beco
in one or more of its divisions?

Solution
 ts in three divisions: industrial,
 sion annually purchases 10,000
e in manufacturing one of its own
rowth in its markets. The
ncrease its purchases of part 23–
 ision is at full capacity. No new
  because top management sees
ase soon.
 or from Britton Electric, a customer
 The industrial division’s sales to
 about part 23–6711.




sion should purchase the additional

ncelled if the commercial division does
e, and would the desired transfer

t 1? How can AMI become more competitive
Problem 18-48 Return on Investment; Residual Income
                        Background
Jump-Start Co. (JSC), a subsidiary of Mason Industries, manufactures go-carts and oth
recreational centers that feature gocart tracks as well as miniature golf courses, batting
increased in popularity. As a result, Mason management has been pressuring JSC to di
recreational areas. Recreational Leasing Inc. (RLI), one of the largest firms that leases a
recreational centers, is looking for a buyer. Mason’s top management believes that RLI’
investment of $3.2 million and has strongly urged Bill Grieco, JSC’s division manager, to
Bill has reviewed RLI’s financial statements with his controller, Marie Donnelly; they beli
be in JSC’s best interest. ―If we decide not to do this, the Mason people are not going to
convince them to base our bonuses on something other than ROI, maybe this acquisitio
How would we do if the bonuses were based on RI using the company’s 15 percent cos

Mason has traditionally evaluated all divisions on the basis of ROI, which is the ratio of o
The desired rate of return for each division is 20 percent. The management team of any
increase in the ROI is automatically eligible for a bonus. The management of divisions
provide convincing explanations for the decline to be eligible for a bonus. The bonus for
limited to 50 percent of the amount of the bonus paid to divisions reporting an increase.

The following are the condensed financial statements of JSC and RLI for the fiscal year



                    Problem Information

                                                 JSC               RLI
Sales revenue                                $10,500,000            —
Leasing revenue                                   —            $2,800,000
Variable expenses                             7,000,000         1,000,000
Fixed expenses                                1,500,000         1,200,000
Operating income                             $2,000,000         $600,000
Current assets                               $2,300,000        $1,900,000
Long-term assets                              5,700,000         1,100,000
Total assets                                 $8,000,000        $3,000,000
Current liabilities                          $1,400,000         $850,000
Long-term liabilities                         3,800,000         1,200,000
Shareholders’ equity                          2,800,000          950,000
Total liabilities and shareholders’ equity   $8,000,000        $3,000,000
 Cost of capital =                             0.15

                     18-48 Requirements

1. If Mason Industries continues to use ROI as the sole measure of division performance,
is reluctant to acquire RLI. Support your answer with appropriate calculations.
2. If Mason Industries could be persuaded to use RI to measure JSC’s performance, expla
be more willing to acquire RLI. Support your answer with appropriate calculations.
3. Discuss how the behavior of division managers is likely to be affected by the use of
a. ROI as a performance measure.
b. RI as a performance measure.
(CMA Adapted)

Solution
ures go-carts and other recreational vehicles. Family
 golf courses, batting cages, and arcade games have
  pressuring JSC to diversify into some of these other
 est firms that leases arcade games to these family
ent believes that RLI’s assets could be acquired for an
 s division manager, to consider the acquisition.
rie Donnelly; they believe that the acquisition may not
eople are not going to be happy,‖ Bill said. ―If we could
 maybe this acquisition would look more attractive.
pany’s 15 percent cost of capital?‖

 which is the ratio of operating income to total assets.
agement team of any division reporting an annual
agement of divisions reporting a decline in ROI must
bonus. The bonus for divisions with declining ROI is
eporting an increase.

RLI for the fiscal year ended May 31, 2007.
division performance, explain why JSC
 culations.
C’s performance, explain why JSC would
e calculations.
cted by the use of
Problem 18-49 Return on Investment
                             Background
  Videonet Company manufactures highly specialized products for networking video-confe
  equipment. Production of specialized units are, to a large extent, performed under contra
  units manufactured according to marketing projections. Maintenance of customer equipm
  important area of customer satisfaction. With the recent downturn in the computer indus
  conferencing equipment segment has suffered, causing a slide in Videonet’s financial pe
  income statement for the fiscal year ended October 31, 2007, follows.

                         Problem Information

                                VIDEONET COMPANY
                                  Income Statement
                         For the Year Ended October 31, 2007
                                    (000s omitted)
Net sales
Equipment
Maintenance contracts
Total net sales
Expenses
Cost of goods sold
Customer maintenance
Selling expense
Administrative expense
Interest expense
Total expense
Income before taxes
Income taxes
Net income

Videonet’s return on sales before interest and taxes was 14.5 percent in fiscal 2007 w
was 18 percent. Its total asset turnover was two times, and its return on average asse
interest and taxes was 29 percent, both well below the industry average. To improve p
these ratios closer to, or above, industry averages, Bill Hunt, Videonet’s president, es
the following goals for fiscal 2008:


Return on sales before interest and taxes                          15%
Total asset turnover                                                3
Return on average assets before interest and taxes                35%

To achieve Hunt’s goals, Videonet’s management team considered the growth in the inte
conferencing market and proposed the following actions for fiscal 2008:

Increase equipment sales prices by 10 percent.

Increase the cost of each unit sold by 3 percent for needed technology, and quality impro
increased variable costs.

Increase maintenance inventory by $250,000 at the beginning of the year and add two ma
technicians at total cost of $130,000 to cover wages and related travel expenses. These r
to improve customer service and response time. The increased inventory will be financed
rate of 12 percent; no other borrowings or loan reductions are contemplated during fiscal
will be held to fiscal 2007 levels.

Increase selling expenses by $250,000 but hold administrative expenses at 2007 levels.

The effective rate for 2008 federal and state taxes is expected to be 40 percent, the same

These actions were taken to increase equipment unit sales by 8 percent, with a correspon
growth in maintenance contracts.


                           Relevant Information
Increase in equipment sales prices                         10.00%
Increase in equipment unit sales                            8.00%
Growth in maintenance contracts                             8.00%
Increase in cost for needed technology                      3.00%
Increase in selling expenses                                 250
Add 2 maintenance technicians                                130
Interest rate for financing                                12.00%
Tax Rate                                                   40.00%


                         18-49 Requirements

1. Prepare a budgeted income statement for Videonet for the fiscal year ending October 3
assumption that the proposed actions are implemented as planned and that the increased
will be met.
2. Calculate the following ratios for Videonet for fiscal year 2008 and determine whether B
will be achieved.
a. Return on sales before interest and taxes.
b. Total asset turnover.
c. Return on average assets before interest and taxes.
3. Discuss the limitations and difficulties that can be encountered in using the ratios in req
when making comparisons to industry averages.
(CMA Adapted)

Solution
  for networking video-conferencing
ent, performed under contract, with standard
 enance of customer equipment is an
nturn in the computer industry, the video-
de in Videonet’s financial performance. Its
, follows.




7


                 $6,500
                   1,800
                 $8,300

                   4,600
                   1,000
                     600
                     900
                     150
                 $7,250
                   1,050
                     420
                   $630

.5 percent in fiscal 2007 when the industry average
 ts return on average assets before
stry average. To improve performance and raise
, Videonet’s president, established
          times


ered the growth in the international video-
cal 2008:



 hnology, and quality improvements and for


 of the year and add two maintenance
ed travel expenses. These revisions are intended
d inventory will be financed at an annual interest
 contemplated during fiscal 2008. All other assets


 expenses at 2007 levels.

 to be 40 percent, the same as 2007.

 8 percent, with a corresponding 8 percent




          (000's omitted)
          (000's omitted)




scal year ending October 31, 2008, on the
ned and that the increased sales objectives

8 and determine whether Bill Hunt’s goals




ed in using the ratios in requirement 3, particularly
Problem 18-50 Strategy; Strategic Performance Measurement; Transfer Pricing
                                Background
 Ajax Consolidated has several divisions; however, only two transfer products to other divi
 division refines toldine, which it transfers to the metals division where toldine is processed
 is sold to customers for $150 per unit. Ajax currently requires the mining division to transf
 output of 400,000 units of toldine to the metals division at total manufacturing cost plus 10
 Unlimited quantities of toldine can be purchased and sold on the open market at $90 per
 division could sell all the toldine it produces at $90 per unit on the open market, but it wou
 incur a variable selling cost of $5 per unit.
 Brian Jones, the mining division’s manager, is unhappy transferring the entire output of to
 metals division at 110 percent of cost. In a meeting with Ajax management, he said, ―Why
 my division be required to sell toldine to the metals division at less than market price? Fo
 ended in May, metals’ contribution margin was more than $19 million on sales of 400,000
 mining’s contribution was just over $5 million on the transfer of the same number of units.
 subsidizing the profitability of the metals division. We should be allowed to charge the
 market price for toldine when we transfer it to the metals division.‖
 The following is the detailed unit cost structure for both the mining and metals divisions fo
 ended May 31, 2007:
                           Problem Information

                                                                    Cost per Unit
                                                          Mining Division        Metals D
Transfer price from mining division                                      —
Direct material                                                        $12
Direct labor                                                             16
Manufacturing overhead                                                   32 *
Total cost per unit                                                    $60

 * Manufacturing overhead in the mining division is 25 percent fixed and 75 percent variab
 † Manufacturing overhead in the metals division is 60 percent fixed and 40 percent variab


Manufacturing overhead in the mining division                            25%   Fixed
Manufacturing overhead in the mining division                            75%   Variable
Manufacturing overhead in the metals division                            60%   Fixed
Manufacturing overhead in the metals division                            40%   Variable

Additional information:
    Metals Division, external SP/unit =                              $150.00
    Annual output of mining division =                               400,000 units
    Current TP, markup over full mfg cost =                                0
    External market price, unit of toldine =                          $90.00
    Add'l cost per unit on external transfers =                        $5.00


                           18-50 Requirements

1. Explain whether transfer prices based on cost are appropriate as a divisional performan
2. Using the market price as the transfer price, determine the contribution margin for both
year ended May 31, 2007.
3. If Ajax were to institute the use of negotiated transfer prices and allow divisions to buy a
market, determine the price range for toldine that both divisions would accept. Explain you
4. Identify which of the three types of transfer prices—cost based, market based, or negot
to elicit desirable management behavior at Ajax and thus benefit overall operations. Expla

Solution
t; Transfer Pricing

 roducts to other divisions. The mining
 toldine is processed into an alloy and
 ng division to transfer its total annual
acturing cost plus 10 percent.
n market at $90 per unit. The mining
en market, but it would

he entire output of toldine to the
 ment, he said, ―Why should
an market price? For the year just
 on sales of 400,000 units while
 me number of units. My division is
ed to charge the

d metals divisions for the fiscal year



st per Unit
           Metals Division
                      $66
                         6
                        20
                        25 †
                    $117

nd 75 percent variable.
nd 40 percent variable.


      Fixed
      Variable
      Fixed
      Variable
     units




divisional performance measure and why.
ion margin for both divisions for the

ow divisions to buy and sell on the open
 accept. Explain your answer.
 ket based, or negotiated—is most likely
all operations. Explain your answer.
Problem 18-51 Transfer Pricing; International
    Better Life Products (BLP), Inc., is a large U.S.–based manufacturer of health car
    cushions, braces, and other remedies for a variety of health problems experience
    persons. BLP knows that its industry is price competitive and hopes to compete th
    within the United States, where it has a well-established brand image. Because o
    conditions, BLF is focusing on cost and price reductions as a principal way to attr
    rising domestic production costs, lower production costs in other countries, and a
    demand for its products, BLP manufactures some of these products outside the U
    materials for use by foreign manufacturers is shipped from the United States to th
    which assembles the final product. In this way, BLP takes advantage of the foreig
    For this purpose, BLP has formed three divisions, one in the United States to pur
    assembly of the raw materials; one a foreign division to complete the manufacturi
    intensive components of manufacturing; and one a marketing and sales division i
    BLP’s products are approximately 80 percent in the United States, 10 percent in C
    worldwide. The foreign divisions tend to focus only on manufacturing because of
    products and because of BLP’s desire to have the U.S. sales division coordinate
    has 18 U.S. divisions and 23 foreign divisions operating in this manner. Foreign d
    United States are subject to customs duties according to the U.S. Tariff Code, wh
    foreign-based manufacturing. However, the code requires U.S. companies to pay
    in foreign countries. For example, a product imported from an Argentine company
    only the amount of the product’s cost resulting from labor incurred in Argentina. T
    $10 of materials shipped from the United States to Argentina that incurs $10 of la
    charged a tariff based on the $10 of labor costs, not the $20 of total product cost.
    having as small a portion of total product cost from the foreign country as possible
    BLP division managers, including those of the foreign manufacturing facilities, are
    profit. Jorge Martinez is the manager of the manufacturing plant in Argentina; his
    based on meeting profit targets. BLP uses a transfer pricing approach common i
    the company’s divisions to determine the transfer pricing autonomously through in
    recent years, however, top management has played an increased role in such ne
    the divisions determine a transfer price that can lead to increased taxes, foreign e
    the corporate financial function becomes involved. This has meant that the transf
    divisions to U.S. sales divisions have fallen to reduce the value added by the fore
    reduce the tariffs. To avoid problems with U.S. and Argentine government agenci
    been reduced slowly over time. One effect of this transfer pricing strategy has be
    the foreign divisions’ profitability. Jorge and others have difficulty meeting their pr
    compensation goals because of the continually declining transfer prices.
    Required

    1. Assess BLP’s manufacturing and marketing strategies. Are they consistent with
    you consider to be the firm’s overall business strategy?
    2. Assess BLP’s performance measurement system. What changes would you su
    compensation goals because of the continually declining transfer prices.
    Required

    1. Assess BLP’s manufacturing and marketing strategies. Are they consistent with
    you consider to be the firm’s overall business strategy?
    2. Assess BLP’s performance measurement system. What changes would you su

Solution
  nufacturer of health care products; it specializes in
 th problems experienced by elderly and disabled
and hopes to compete through rapid growth, primarily
 rand image. Because of the competitive industry
 s a principal way to attract customers. Because of
n other countries, and a modest increase in global
e products outside the United States. Much of the
m the United States to the foreign manufacturer,
  advantage of the foreign country’s lower labor costs.
 he United States to purchase and perform limited
omplete the manufacturing, especially of the labor-
 ting and sales division in the United States. Sales of
d States, 10 percent in Canada, and 10 percent
 nufacturing because of the specialized nature of the
  les division coordinate all sales activities. BLP now
   this manner. Foreign divisions’ shipments to the
 he U.S. Tariff Code, which adds to BLP’s cost of the
   U.S. companies to pay duty on only the value added
m an Argentine company to BLP pays customs on
 incurred in Argentina. To illustrate, a product with
 ina that incurs $10 of labor costs in Argentina is
 20 of total product cost. Thus, for tariff purposes,
 eign country as possible is advantageous to BLP.
nufacturing facilities, are evaluated on the basis of
g plant in Argentina; his compensation from BLP is
 ng approach common in the industry to allow each of
autonomously through interdivision negotiations. In
 creased role in such negotiations. In particular, when
 creased taxes, foreign exchange exposure, or tariffs,
as meant that the transfer prices charged by foreign
 value added by the foreign country and thereby
 tine government agencies, the transfer prices have
   pricing strategy has been the continued decline of
 ifficulty meeting their profit targets and personal
 ransfer prices.


 Are they consistent with each other and with what

 t changes would you suggest and why?
ransfer prices.


Are they consistent with each other and with what

t changes would you suggest and why?
Problem 18-52 Transfer Pricing; International Taxes; Ethics
              Background

 Target Manufacturing, Inc., is a multinational firm with sales and manufacturing units in 1
 countries. One of its manufacturing units, in country X, sells its product to a retail unit in
 country Y for $200,000. Country X unit has manufacturing costs of $100,000 for these
 products. The retail unit in country Y sells the product to final customers for $300,000. Ta
 is considering adjusting its transfer prices to reduce overall corporate tax liability.



           Problem Information

               $200,000
               $100,000
               $300,000
               $240,000
                    20%
                    40%

           18-52 Requirements

1. Assume that both country X and country Y have corporate income tax rates of 40 perce
special tax treaties or benefits apply to Target. What would be the effect on Target’s total
manufacturing unit raises its price from $200,000 to $240,000?
2. What would be the effect on Target’s total taxes if the manufacturing unit raised its price
to $240,000 and the tax rate in country X is 20 percent and in country Y is 40 percent?
3. Comment on the ethical issues, if any, you observe in this case.

Solution
s


manufacturing units in 15
oduct to a retail unit in
 f $100,000 for these
omers for $300,000. Target
 ate tax liability.




me tax rates of 40 percent and that no
effect on Target’s total tax burden if the

 ring unit raised its price from $200,000
 try Y is 40 percent?
Problem 18-53 Strategic Performance Measurement: International; Strategy; Se
   With the multinational company (MNC) becoming a significant business structure th
   growing problem is developing in the analysis of the MNC’s financial results. When
   problem occurred, the U.S. dollar was strengthening considerably relative to other
   economic problems in many developing countries, it also created a problem in the
   multinational’s subsidiaries and their contribution to its total results. Security Syste
   financial services for dealers and consumers in a variety of construction and consu
   is searching for the proper method to evaluate its subsidiaries. Of concern is the su
   the company’s overall earnings and how to evaluate whether the specific goals dev
   management have been met. In search of answers, the company is concerned wit
   Analysis of results: In local currency or U.S. dollars?

   Management’s explanation of variances: In local currency or U.S. dollars? What sh
   comparative data: Plan or forecast? The firm has six distinctive business segments
   housing market: consumer appliance market, commercial nonresidential constructi
   home furnishings market, automotive market, and capital goods markets. Last year
   percent of its revenues and 35 percent of its earnings from its international subsidia
   when one British pound sterling equaled $2.33 U.S. (whereas now it’s one pound =
   achieved 35 percent of its revenue—but more significantly, 47 percent of its earnin
   subsidiaries. During the past five years, although the U.S. dollar equivalent of earn
   subsidiaries has declined from 47 percent of the total to 35 percent, most operation
   steady gains from year to year in the local currency. All operations report their mon
   firm’s world headquarters in U.S. dollars.

   They use the existing exchange rate at the close of business on the last day of the
   exchange based on accounting guidelines (except for one or two special situations
   monthly financial data are made against a financial plan that uses a predetermined
   various months of the year. Over the past five years, as the U.S. dollar has fluctua
   currencies, the firm has analyzed the financial results of its operations totally in U.S
   its results to a fixed-plan exchange rate. The firm establishes exchange rates to be
   times optimistically, and then sets an earnings per share target on that basis. If the
   more, the firm misses its targets and prepares statements showing that a particular
   targets when, in fact, all of the group’s operations could have exceeded their local
   on the comparison because of unfavorable exchange rate effects.

   Required
   How should the firm measure its results to enhance its competitiveness? How can
   target if it uses local currencies in the reporting system? Where does the responsib
   attainment of goals lie? (CMA Adapted)


Solution
rnational; Strategy; Service Industry
ant business structure throughout the world, a
 financial results. When the incidents in this
 erably relative to other currencies. Besides causing
eated a problem in the proper evaluation of a
 results. Security System Corporation provides
 construction and consumer product areas. The firm
es. Of concern is the subsidiaries’ contribution to
er the specific goals developed by the subsidiaries’
mpany is concerned with the following concepts:


 r U.S. dollars? What should the time frames be for
 tive business segments in the new-residential-
onresidential construction, consumer aftermarket,
oods markets. Last year the company achieved 30
its international subsidiaries. However, years ago
as now it’s one pound = $1.45 U.S.), the firm
 47 percent of its earnings—from its international
 ollar equivalent of earnings from the international
percent, most operations have reported significant,
 rations report their monthly financial data to the


 s on the last day of the month. The firm reports the
or two special situations). The comparisons of the
 t uses a predetermined exchange rate for the
e U.S. dollar has fluctuated against foreign
 operations totally in U.S. dollars and then compares
es exchange rates to be used each year, many
rget on that basis. If the dollar strengthens even
 howing that a particular group missed its planned
ve exceeded their local currency plans but are losing
effects.


petitiveness? How can it safeguard its overall EPS
here does the responsibility for the U.S. dollar
Problem 18-54 Transfer Pricing; Decision Making
                    Background

Bramwell Adhesives, Inc, manufactures chemicals and adhesives for commercial and
Division A is currently purchasing 300 barrels per year of a required chemical (PB4) fro
supplier for $550 per barrel. The $550 price is a competitive, fair price, but Division A i
with the service and reliability of the supplier. Fortunately, Division A has discovered th
Bramwell division, Division B, has the technology to manufacture PB4. Division B woul
purchase some new equipment to produce PB4, but the equipment is readily available
installed in a timely manner for $90,000. With the purchase of the machine, Division B
capacity to produce up to 1,000 barrels of the chemical per year. Division A would be w
commit to a three-year contract for 300 barrels per year if the divisions could agree on
price.

Division B projects the following costs per barrel for PB4.


                Problem Information

Variable manufacturing cost                              $200
Fixed costs per barrel                              *      300
Profi t margin for Division B (20%)                        100
Total projected price of PB4 to Div A                    $600

 * Allocation of the cost of purchased equipment over three years,
 based on an assumed production of 300 barrels in each of the three
 years.

                18-54 Requirements

1. Is the purchase of the new equipment for $90,000 relevant to the decision to transfer in
the determination of the transfer price?
2. Should Division B sell PB4 to Division A and, if so, at what price?

Solution
  commercial and industrial use.
chemical (PB4) from an outside
e, but Division A is not satisfied
 has discovered that another
 4. Division B would have to
s readily available and can be
achine, Division B would have the
 sion A would be willing to
ns could agree on a transfer




 ision to transfer internally and/or
Problem 18-55 Return on Customer; Review of Chapter 5
                           Background

  The concept of return on investment has been adapted widely for a variety of uses. One
  recent development is to extend customer profitability analysis to include the concept of
  ―return on customer.‖ In Chapter 5, we presented an approach for using ABC costing to
  determine the full cost of serving a customer, including product and service, thereby
  determining the net profit from serving that customer. The analysis was further extended
  in Chapter 5 to calculate a measure of the expected value of the customer based on
  expected future sales.
  That value was called customer lifetime value (CLV) , which is the net present value of a
  estimated future profits from the customer. For example, assume a customer is expecte
  to produce profits of $20,000 per year for the next three years. Using a discount rate of 6
  percent, the CLV for this customer is 2.673 × $20,000 = $53,460. The PV factor, 2.673,
  obtained from Table 2 of the present value tables at the end of the text.
  Return on customer (ROC) can be measured as the increase in customer value plus the
  current year profit on the customer, relative to the prior year value of the customer. The
  first step in calculating ROC is to determine the customer lifetime value (CLV) at the end
  of each year. CLV can rise or fall, as our projections of future profits from the customer
  increase or decrease. Suppose we have the following information for a customer Y:

                      Problem Information

Customer Lifetime Value at the end of 2006 =            $2,000,000
Customer Lifetime Value at the end of 2007 =            $2,500,000
Profit on sales to customer Y during 2007 =               $250,000

ROC for customer Y for 2007 is determined as follows:

ROC = Profit from the customer Y in 2007 + Change in CLV from 2006 to 2007/
CLV for customer Y in 2006

ROC for customer Y = $250,000 +($2,500,000-2,000,000)/2,000,000
                                        Equals 37.50%

ROC gives management a way to further analyze the profitability of a given customer.
The goal is to attract and retain high ROC customers.
                       18-55 Requirements

Assume Customer X has a CLV at the beginning of the year of $150,000, a CLV at the en
year of $75,000, and profits from sales to X of $25,000 during the year. Customer Z has a
of the year of $100,000, a CLV at the beginning of the year of $50,000, and profits from sa
$10,000. Determine the ROC for each customer and interpret the results for these two cus

Relevant Information: Customer X
CLV at beginning of year                                  $150,000
CLV at end of year                                         $75,000
Profits from sales to X                                    $25,000

Relevant Information: Customer Y
CLV at beginning of year                                   $50,000
CLV at end of year                                        $100,000
Profits from sales to Y                                    $10,000

Solution
apter 5


widely for a variety of uses. One
nalysis to include the concept of
proach for using ABC costing to
 roduct and service, thereby
 e analysis was further extended
ue of the customer based on

hich is the net present value of all
  assume a customer is expected
years. Using a discount rate of 6
 $53,460. The PV factor, 2.673, is
end of the text.
 ease in customer value plus the
 ear value of the customer. The
 r lifetime value (CLV) at the end
uture profits from the customer
formation for a customer Y:




V from 2006 to 2007/


 2,000,000


tability of a given customer.
ar of $150,000, a CLV at the end of the
  ing the year. Customer Z has a CLV at the end
 r of $50,000, and profits from sales this year of
pret the results for these two customers.
Problem 18-56 Return on Investment for Innovative Companies
 A recent survey by BusinessWeek and the Boston Consulting Group identified the w
 companies, looking at three dimensions of innovation: process innovation, product in
 model innovation. The top five companies were Apple, Google, 3M, Toyota, and Mic
 companies were great performers over the 10 year period, 1995–2005. The 25 comp
 return on sales of 3.4 percent in comparison to .4 percent for the Standard & Poor’s
 The top 25 stock returns, based on increase in stock price and dividends over this 10
 14.3 percent annual return, in contrast to the 11.1 percent return for the S&P Global
 are surpassing the Global 1200 companies in part because of superior innovation.

 Required What are the issues to consider in calculating the return on investment, re
 for a highly innovative company?

Solution
nies
Group identified the world’s 25 most innovative
innovation, product innovation, and business
 3M, Toyota, and Microsoft. The top 25
5–2005. The 25 companies had an average
 e Standard & Poor’s 1200 Global Stock Index.
dividends over this 10-year period, averaged a
n for the S&P Global 1200. These companies
 uperior innovation.

urn on investment, residual income, and EVA ®

				
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