Kent Tessman, manager of a Dairy Products Division, was pleased with his division’s performance over the past three years. Each year, divisional profits had increased, and he had earned a sizable bonus. (Bonuses are a linear function of the division’s reported income.) He had also received considerable attention from higher management. A vice president had told him in confidence that if his performance over the next three years matched his first three, he would be promoted to higher management.
Determined to fulfill these expectations, Kent made sure that he personally reviewed every capital budget request. He wanted to be certain that any funds invested would provide good, solid returns. (The division’s cost of capital is 10 percent.) At the moment, he is reviewing two independent requests. Proposal A involves automating a manufacturing operation that is currently labor intensive. Proposal B centers on developing and marketing a new ice cream product. Proposal A requires an initial outlay of $250,000, and Proposal B requires $312,500. Both projects could be funded, given the status of the division’s capital budget. Both have an expected life of six years and have the following projected after-tax cash flows:
After careful consideration of each investment, Kent approved funding of Proposal A and rejected Proposal B.
Required:
- 1. Compute the
NPV for each proposal. - 2. Compute the payback period for each proposal.
- 3. According to your analysis, which proposal(s) should be accepted? Explain.
- 4. Explain why Kent accepted only Proposal A. Considering the possible reasons for rejection, would you judge his behavior to be ethical? Explain.
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Chapter 19 Solutions
EBK CORNERSTONES OF COST MANAGEMENT
- Dana Baird was manager of a new Medical Supplies Division. She had just finished her second year and had been visiting with the companys vice president of operations. In the first year, the operating income for the division had shown a substantial increase over the prior year. Her second year saw an even greater increase. The vice president was extremely pleased and promised Dana a 5,000 bonus if the division showed a similar increase in profits for the upcoming year. Dana was elated. She was completely confident that the goal could be met. Sales contracts were already well ahead of last years performance, and she knew that there would be no increases in costs. At the end of the third year, Dana received the following data regarding operations for the first three years: The predetermined fixed overhead rate is based on expected actual units of production and expected fixed overhead. Expected production each year was 10,000 units. Any under-or overapplied fixed overhead is closed to Cost of Goods Sold. Assumes a LIFO inventory flow. Upon examining the operating data, Dana was pleased. Sales had increased by 20 percent over the previous year, and costs had remained stable. However, when she saw the yearly income statements, she was dismayed and perplexed. Instead of seeing a significant increase in income for the third year, she saw a small decrease. Surely, the Accounting Department had made an error. Required: 1. Explain to Dana why she lost her 5,000 bonus. 2. Prepare variable-costing income statements for each of the three years. Reconcile the differences between the absorption-costing and variable-costing incomes. 3. If you were the vice president of Danas company, which income statement (variable-costing or absorption-costing) would you prefer to use for evaluating Danas performance? Why?arrow_forward“I know headquarters wants us to add that new product line,” said Dell Havasi, manager of Billings Company’s Office Products Division. “But I want to see the numbers before I make a decision. Our division’s return on investment (ROI) has led the company for three years, and I don’t want any letdown.” Billings Company is a decentralized wholesaler with five autonomous divisions. The divisions are evaluated using ROI, with year-end bonuses given to the divisional managers who have the highest ROIs. Operating results for the company’s Office Products Division for this year are given below: Sales $ 22,440,000 Variable expenses 14,094,600 Contribution margin 8,345,400 Fixed expenses 6,130,000 Net operating income $ 2,215,400 Divisional average operating assets $ 4,480,000 The company had an overall return on investment (ROI) of 18.00% this year (considering all divisions). Next year the Office Products Division has an opportunity to add a new product requiring $2,430,600 of…arrow_forward“I know headquarters wants us to add that new product line,” said Dell Havasi, manager of Billings Company’s Office Products Division. “But I want to see the numbers before I make a decision. Our division’s return on investment (ROI) has led the company for three years, and I don’t want any letdown.” Billings Company is a decentralized wholesaler with five autonomous divisions. The divisions are evaluated using ROI, with year-end bonuses given to the divisional managers who have the highest ROIs. Operating results for the company’s Office Products Division for this year are given below: Sales $ 22,440,000 Variable expenses 14,094,600 Contribution margin 8,345,400 Fixed expenses 6,130,000 Net operating income $ 2,215,400 Divisional average operating assets $ 4,480,000 The company had an overall return on investment (ROI) of 18.00% this year (considering all divisions). Next year the Office Products Division has an opportunity to add a new product requiring $2,430,600 of…arrow_forward
- The accounting department head of MOOG Controls Phils. has asked his financial manager to provide a pro forma statement of the company's "value" under a variety of prospective expansion scenarios, with the assumption that the company's many divisions will always be a single entity. The company's manager is concerned because, despite the fact that the company's competitors are few, their yearly sales growth has topped 60% in each of the last five years. The accounting department head advised that the valuation estimates be based on the company's profits of Php5.2 billion (which have yet to be paid out to investors) and the average interest rate over the past 20 years (7 percent) in each of the following profit growth scenarios: A. 5.5% annual growth rate of profits. B. 2.8% annual growth rate of profits. C. 0% annual growth rate of profits. D. 10.25% annual growth rate of profits.arrow_forwardTom and Jerry are both managers of sales teams at Flint Corp., a furniture company whose most popular item is a tweed couch. Tom and Jerry are very competitive and each attempt to outperform one another every year. Currently, Tom's department has better metrics, which has resulted in larger bonuses for Tom and his team. Flint Corp. evaluates both departments based upon each team's respective return on investment and economic value added. The departments reported the following financial data during the most recent year: Operating Income Sales Average Operating Assets Total Assets Current Liabilities Jerry $125,613 $2,791,400 $953,900 $1,103,880 $208,630 Tom $183,995 $3,679,900 $1,321,120 $1,521,480 $296,860 It should be noted that Flint uses average operating assets as its definition of investment, and it has a minimum required rate of return of 8.72% and a tax rate of 22%. Flint has used a variety of ways to acquire capital and has the current makeup: proportion of equity is 38%, the…arrow_forwardSunshine Industrial Ltd, a massive retailer of electronic products, is organised in four separatebusiness divisions. The four divisional managers are evaluated at year-end, and bonuses areawarded based on return on investment (ROI). Last year, the corporation as a whole achieved aROI of 13%.During the past week, the divisional manager of the Asia-Pacific Division was approachedabout the possibility of acquiring a competitor that had decided to redirect its retail activities.The following data relates to the recent performance of the Asia-Pacific Division and thecompetitor:Asia-Pacific Division CompetitorInvested capital $1,850,000 $ 625,000Sales $8,400,000 $5,200,000Variable costs 70% of sales 65% of salesFixed costs $2,150,000 $1,670,000Management has determined that in order to upgrade the competitor to Sunshine’s standards,an additional $375,000 of invested capital would be needed.Required:(a) Compute the ROI of the Asia-Pacific Division for the following scenarios:(i) before the…arrow_forward
- know headquarters wants us to add that new product line," said Dell Havasi, manager of Billings Company's Office Products Division. "But I want to see the numbers before I make a decision. Our division's return on investment (ROI) has led the company for three years, and I don't want any letdown." Billings Company is a decentralized wholesaler with five autonomous divisions. The divisions are evaluated using ROL with year-end bonuses given to the divisional managers who have the highest ROIS. Operating results for the company's Office Products Division for this year are given below: Sales Variable expenses Contribution margin Fixed expenses Net operating income Divisional average operating assets The company had an overall return on investment (ROI) of 17.00% this year (considering all divisions). Next year the Office Products Division has an opportunity to add a new product requiring $2,755,000 of additional average operating assets. The annual cost and revenue estimates for the new…arrow_forwardFaced with headquarters' desire to add a new product line, Stefan Grenier, manager of Bilti Products' East Division, felt that he had to see the numbers before he made a move. His division's ROI has led the company for three years, and he doesn't want any letdown. Bilti Products is a decentralized wholesaler with four autonomous divisions. The divisions are evaluated on the basis of ROI, with year- end bonuses given to divisional managers who have the highest ROI. Operating results for the company's East Division for last year are given below: Sales Variable expenses Contribution margin Fixed expenses Operating income Divisional operating assets The company had an overall ROI of 16% last year (considering all divisions). The new product line that headquarters wants Grenier's East Division to add would require an investment of $3,800,000. The cost and revenue characteristics of the new product line per year would be as follows: Sales Variable expenses Fixed expenses $ 11,400,000 $…arrow_forwardFaced with headquarters’ desire to add a new product line, Stefan Grenier, manager of Bilti Products’ East Division, felt that he had to see the numbers before he made a move. His division’s ROI has led the company for three years, and he doesn’t want any letdown. Bilti Products is a decentralized wholesaler with four autonomous divisions. The divisions are evaluated on the basis of ROI, with year-end bonuses given to divisional managers who have the highest ROI. Operating results for the company’s East Division for last year are given below: Sales $ 28,700,000 Variable expenses 14,390,000 Contribution margin 14,310,000 Fixed expenses 12,301,000 Operating income $ 2,009,000 Divisional operating assets $ 7,175,000 The company had an overall ROI of 16% last year (considering all divisions). The new product line that headquarters wants Grenier’s East Division to add would require an investment of $4,100,000. The cost and revenue characteristics…arrow_forward
- Faced with headquarters’ desire to add a new product line, Stefan Grenier, manager of Bilti Products’ East Division, felt that he had to see the numbers before he made a move. His division’s ROI has led the company for three years, and he doesn’t want any letdown. Bilti Products is a decentralized wholesaler with four autonomous divisions. The divisions are evaluated on the basis of ROI, with year-end bonuses given to divisional managers who have the highest ROI. Operating results for the company’s East Division for last year are given below: Sales $ 23,800,000 Variable expenses 13,760,000 Contribution margin 10,040,000 Fixed expenses 8,374,000 Operating income $ 1,666,000 Divisional operating assets $ 5,950,000 The company had an overall ROI of 16% last year (considering all divisions). The new product line that headquarters wants Grenier’s East Division to add would require an investment of $3,400,000. The cost and revenue characteristics of…arrow_forwardBernice Mountaindog was glad to be back at Sea Shore Salt. Employees were treated well. When she had asked a year ago for a leave of absence to complete her degree in finance, top management promptly agreed. When she returned with a honors degree, she was promoted form administrative assistant (she had been secretary to Joe-Bob Brinepool, the president) to treasury analyst.Bernice thought the company’s prospect were good. Sure, table salt was a mature business, but Sea Shore Salt had grown steadily at the expense of its less well known competitors. The company’s brand name was an important advantage, despite the difficulty most customers had in pronouncing it rapidly.Bernice started work on January 2, 2009. The first 2 weeks went smoothly. Then Mr. Brinepool’s cost of capital to other managers. The memo came as a surprise to Bernice, so she stayed late to prepare for the questions that would surely come the next day. The company’s bank charged interest at current market rates, and the…arrow_forwardI know headquarters wants us to add that new product line,” said Dell Havasi, manager of Billings Company’s Office Products Division. “But I want to see the numbers before I make any move. Our division’s return on investment (ROI) has led the company for three years, and I don’t want any letdown.” Billings Company is a decentralized wholesaler with five autonomous divisions. The divisions are evaluated on the basis of ROI, with year-end bonuses given to the divisional managers who have the highest ROIs. Operating results for the company’s Office Products Division for this year are given below: Sales $ 23,000,000 Variable expenses 14,365,000 Contribution margin 8,635,000 Fixed expenses 6,220,000 Net operating income $ 2,415,000 Divisional average operating assets $ 5,001,000 The company had an overall return on investment (ROI) of 16.00% this year (considering all divisions). Next year the Office Products Division has an opportunity to add a new…arrow_forward
- Cornerstones of Cost Management (Cornerstones Ser...AccountingISBN:9781305970663Author:Don R. Hansen, Maryanne M. MowenPublisher:Cengage LearningPrinciples of Accounting Volume 1AccountingISBN:9781947172685Author:OpenStaxPublisher:OpenStax College