ROI, RI, decision making. The following data refer to the successful Munger division of Buffett, Inc. Munger makes and sells high-end cordless drills. The drills sell for $80 each, and Munger expects sales of 300,000 units in 2014. Munger’s annual fixed costs are $4 million. The variable cost per drill is $48. Buffett evaluates Munger based on residual income. The total investment attributed to Munger is $16 million, and Buffett has a required rate of return on investment of 20%. Ignore taxes and depreciation expense. Answer each of the following parts independently, unless otherwise stated.1. What is the expected residual income in 2014?2. Munger receives an external special order for 100,000 units at $60 each. If the order is accepted,Munger will have to incur incremental fixed costs of $850,000 and invest an additional $2 million in various assets.What is the effect on Munger’s residual income of accepting the order?3. One of the components Munger manufactures for its drill has a variable cost of $4. An outside vendor has offered to supply the 300,000 units required at a cost of $5.25 per unit. If the component is purchasedoutside, fixed costs will decline by $200,000 and assets with a book value of $760,000 will be sold at book value.Will Munger decide to make or buy the component? Explain your answer.4. One of Munger’s regular customers asks for a special drill made of tempered steel. The customer requires 15,000 drills. Munger estimates its variable cost for these special units at $54 apiece. Munger will also have to undertake new investment of $1,500,000 to produce the drills.What is the minimum selling price that will make the deal acceptable to Munger?5. Assume the same facts as in requirement 4. Also suppose that the customer has offered $82 for each special drill. In addition, the customer has indicated that its purchases of the existing product will dropby 6,000 units.a. What is the net change in Munger’s residual income from taking the offer, relative to its planned 2014 situation?b. At what drop in unit sales of the regular drill would Munger be indifferent to the offer?

Question
Asked Dec 22, 2019
26 views

ROI, RI, decision making. The following data refer to the successful Munger division of Buffett, Inc. Munger makes and sells high-end cordless drills. The drills sell for $80 each, and Munger expects sales of 300,000 units in 2014. Munger’s annual fixed costs are $4 million. The variable cost per drill is $48. Buffett evaluates Munger based on residual income. The total investment attributed to Munger is $16 million, and Buffett has a required rate of return on investment of 20%. Ignore taxes and depreciation expense. Answer each of the following parts independently, unless otherwise stated.
1. What is the expected residual income in 2014?
2. Munger receives an external special order for 100,000 units at $60 each. If the order is accepted,Munger will have to incur incremental fixed costs of $850,000 and invest an additional $2 million in various assets.
What is the effect on Munger’s residual income of accepting the order?
3. One of the components Munger manufactures for its drill has a variable cost of $4. An outside vendor has offered to supply the 300,000 units required at a cost of $5.25 per unit. If the component is purchased
outside, fixed costs will decline by $200,000 and assets with a book value of $760,000 will be sold at book value.
Will Munger decide to make or buy the component? Explain your answer.
4. One of Munger’s regular customers asks for a special drill made of tempered steel. The customer requires 15,000 drills. Munger estimates its variable cost for these special units at $54 apiece. Munger will also have to undertake new investment of $1,500,000 to produce the drills.
What is the minimum selling price that will make the deal acceptable to Munger?
5. Assume the same facts as in requirement 4. Also suppose that the customer has offered $82 for each special drill. In addition, the customer has indicated that its purchases of the existing product will drop
by 6,000 units.
a. What is the net change in Munger’s residual income from taking the offer, relative to its planned 2014 situation?
b. At what drop in unit sales of the regular drill would Munger be indifferent to the offer?

check_circle

Expert Answer

Step 1

1. Compute expected residual income in 2014 as shown below:

help_outline

Image Transcriptionclose

Amount (S) |$24,000,000 $14,400,000 Particulars Sales revenue (S80×300,000) Less: Variable cost ($48x300,000) Contribution margin Less: Fixed costs Operating income (A) Investment (B) Required rate of return (C) Required return on investment (D =BxC) Residual income (A-D) $9,600,000 $4,000,000 $5,600,000 |S16,000,000 20% $3,200,000 $2.400.000

fullscreen
Step 2

2. Compute Munger’s residual income of accepting the special order of 100,000 units as shown below:

help_outline

Image Transcriptionclose

Amount ($) $24,000,000 $6,000,000 $30,000,000 Particulars Sales revenue ($80x300,000) Incremental revenue ($60x100,000) Total revenue (A) Variable cost ($48×300,000) Incremental variable cost ($48×100,000) Total variable cost (B) Fixed costs Incremental fixed costs Total fixed costs (C) Operating income (D=A-B-C)) Investment Incremental investment Total investment (E) Required rate of return (F) Required return on investment (G =E×F) Residual income (D-G) $14,400,000 $4,800,000 $19,200,000 $4,000,000 $850,000 $4,850,000 $5,950,000 $16,000,000 $2,000,000 $18,000,000 20% $3,600,000 %3D $2.350.000

fullscreen
Step 3
  1. Compute profit of Munger to make or buy the component as shown below:

 

Cost of ma...

help_outline

Image Transcriptionclose

Buy ($) so $1,575,000 Make ($) Particulars Purchase price Direct variable cost ($4x300,000) Savings of fixed cost Cost of component $1,200,000 so $200,000 $1,400,000 $1,575,000 SO Buy ($) Make (S) Particulars | $24,000,000 $24.000,000| Sales revenue (S80×300,000) Less: Variable cost [($48-S4)×300,000]; [(S44+S5.25)×300,000] Contribution margin Less: Fixed costs Operating income (A) Investment (B) Required rate of return (C) Required return on investment (D =BxC) Residual income $13.200,000 S14,775,000 |S10,800,000 $9,225,000| $4,000,000 $3.800,000 $6,800,000 $5,425,000 $16,000,000 S15,240,000| 20% $3,200,000 $3,048,000 $3,600,000 $2,377,000 20%

fullscreen

Want to see the full answer?

See Solution

Check out a sample Q&A here.

Want to see this answer and more?

Solutions are written by subject experts who are available 24/7. Questions are typically answered within 1 hour.*

See Solution
*Response times may vary by subject and question.
Tagged in

Business

Accounting

Financial Management

Related Accounting Q&A

Find answers to questions asked by student like you
Show more Q&A
add
question_answer

Q: The comparative balance sheet of Coulson, Inc. at December 31, 20Y2 and 20Y1, is asfollows:Dec. 31, ...

A: Working note:Prepare the schedule in the changes of current assets and liabilities.

question_answer

Q: On September 12, 2,000 shares of Aspen Company are acquired at a price of $50 per share plus a $200 ...

A: Journal entry refers to the recording made by the business in the books of accounts, of all the non-...

question_answer

Q: CVP analysis, income taxes. The Home Style Eats has two restaurants that are open 24 hours a day. Fi...

A: Given information:

question_answer

Q: For all exercises, assume the perpetual inventory system is used unless stated otherwise. Measuring ...

A: Partial income statement with accounting errors.

question_answer

Q: Some individuals have indicated that the FASB must be cognizant of the economic consequences of its ...

A: Generally Accepted Accounting Principles (GAAP): A set of accounting principles, practices and regul...

question_answer

Q: What are the primary advantages of having a Codification of generally accepted accounting principles...

A: Codification: Codification is a source of authoritative generally accepted accounting principles rec...

question_answer

Q: What is costing system refinement? Describe three guidelines for refinement.

A: Broad averaging is also known as peanut butter cost is a costing approach of distributing the overal...

question_answer

Q: Outline the steps in preparing an operating budget.

A: Click to see the answer

question_answer

Q: “Budgets meet the cost–benefit test. They force managers to act differently.” Do you agree? Explain.

A: A budget is a financial plan prepared by the company for a period. It is prepared to estimate the re...