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Part 2. Problems. There are four problems. Each one is worth the score indicated next to the problem number. Show all work for complete credit. You may attach extra pages if you so desire. Please be NEAT when writing your answers. I cannot grade illegible answers. (40 points possible)
1. (10 points) Eban Wares is a division of a major corporation. The following data are for the latest year of operations:
Net operating income $950,000
Average operating assets $4,000,000
The company’s minimum required rate of return 14%
The manager of Eban Wares has an opportunity to add a project with the following characteristics:
Cost of new equipment $1,200,000
Additional revenues $3,000,000
Additional expenses $2,100,000
a. What is the division’s margin (before the new project)?
b. What is the division’s turnover (before the new project)?
c. What is the division’s return on investment (ROI) (before the new project)?
d. What is the division’s residual income (before the new project)?
e. What is the division’s margin (after the new project is added)?
f. What is the division’s turnover (after the new project is added)?
g. What is the division’s return on investment (ROI) (after the new project is added)?
h. What is the division’s residual income (after the new project is added)?
2. (6 points) The Laker Co. and the Warrior Co. are both subsidiary companies owned by the NBA Jam Co. The Laker Co. makes a product called the “Brick” with a variable cost per unit of $9 and total fixed expenses of $400,000. The Laker Co. can sell the product to other companies for $18. The Laker Co. has a capacity of 10,000 units, but is currently selling 9,000 units to outside companies (thus, there is idle capacity of 1,000 units). The Warrior Co. uses the “Brick” in one of its products called the “Championship”. The Warrior Co. can buy the “Brick” from an outside company for $16 per unit. If the Warrior Co. needs 2,000 units of the “Brick”, what would be the range of acceptable transfer prices between the Laker Co. and the Warrior Co.?
3. (10 points) Fothergill Company makes 40,000 units per year of a part it uses in the products it manufactures. The unit product cost of this part is computed as follows:
Direct materials…………………………………. $23.40
Direct labor…………………………………….. 22.30
Variable manufacturing overhead…………. 1.40
Fixed manufacturing overhead……………… 24.60
Unit product cost………………………………… $71.70
An outside supplier has offered to sell the company all of these parts it needs for $59.10 a unit. If the company accepts this offer, the facilities now being used to make the part could be used to make more units of a product that is in high demand. The additional contribution margin on this other product would be $390,000 per year.
If the part were purchased from the outside supplier, all of the direct labor, direct materials and variable manufacturing overhead costs of the part would be avoided. However, $21.90 of the fixed manufacturing overhead cost being applied to the part would continue even if the part were purchased from the outside supplier. This fixed manufacturing overhead cost would be applied to the company’s remaining products.
a. How much of the unit product cost of $71.70 is relevant in the decision of whether to make or buy the part?
b. What is the net total dollar advantage or (disadvantage) of purchasing the part rather than making it? (remember that the facility could be used to produce a different product if we purchased the parts from the outside).
c. What is the maximum amount the company should be willing to pay an outside supplier per unit for the part if the supplier commits to supplying all 40,000 units required each year?
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4. (10 points) (Ignore income taxes in this problem.) Axillar Beauty Products Corporation is considering the production of a new conditioning shampoo which will require the purchase of new mixing machinery. The machinery will cost $310,000, is expected to have a useful life of 10 years, and is expected to have a salvage value of $35,000 at the end of 10 years. The machinery will also need a $25,000 overhaul at the end of year 6. A $40,000 increase in working capital will be needed for this investment project. The working capital will be released at the end of the 10 years. The new shampoo is expected to generate net cash inflows of $80,000 per year for each of the 10 years. Axillar’s discount rate is 14%.
a. What is the net present value of this investment opportunity?
b. Based on your answer to (a) above, should Axillar go ahead with the new conditioning shampoo?
5. (4 points) (Ignore income taxes in this problem.) Jimmy Chitwood, Inc. is considering a project that is estimated to generate annual cash inflows of $35,000. The equipment required for the project would cost $266,210. The project would last 15 years. What is the project’s internal rate of return (round to the nearest percent.)
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