Effect of proposals on divisional performance
A condensed income statement for the Commercial Division of Maxell Manufacturing Inc. for the year ended December 31, 20Y9, is as follows:
Sales | $3,500,000 |
Cost of goods sold | 2,480,000 |
Gross profit | $ 1,020,000 |
Operating expenses | 600,000 |
Income from operations | $ 420,000 |
Invested assets | $2,500,000 |
Assume that the Commercial Division received no charges from service departments. The president of Maxell Manufacturing has indicated that the division's return on a $2,500,000 investment must be increased to at least 21% by the end of the next year if operations are to continue. The division manager is considering the following three proposals:
Proposal 1: Transfer equipment with a book value of $312,500 to other divisions at no gain or loss and lease similar equipment. The annual lease payments would exceed the amount of
Proposal 2: Purchase new and more efficient machining equipment and thereby reduce the cost of goods sold by $560,000 after considering the effects of depreciation expense on the new equipment. Sales would remain unchanged, and the old equipment, which has no remaining book value, would be scrapped at no gain or loss. The new equipment would increase invested assets by an additional $1,875,000 for the year.
Proposal 3: Reduce invested assets by discontinuing a product line. This action would eliminate sales of $595,000, reduce cost of goods sold by $406,700, and reduce operating expenses by $175,000. Assets of $1,338,000 would be transferred to other divisions at no gain or loss.
Instructions
- 1. using the DuPont formula for
return on investment , determine the profit margin, investment turnover, and return on investment for the Commercial Division for the past year. - 2. Prepare condensed estimated income statements and compute the invested assets for each proposal.
- 3. Using the DuPont formula for return on investment, determine the profit margin, investment turnover, and return on investment for each proposal. (Round the investment turnover and return on investment to one decimal place.)
- 4. Which of the three proposals would meet the required 21% return on investment?
- 5. If the Commercial Division were in an industry where the profit margin could not be increased, how much would the investment turnover have to increase to meet the president’s required 21% return on investment?
(1)
Profit margin: This ratio gauges the operating profitability by quantifying the amount of income earned from business operations from the sales generated.
Formula of profit margin:
Investment turnover: This ratio gauges the operating efficiency by quantifying the amount of sales generated from the assets invested.
Formula of investment turnover:
Return on investment (ROI): This financial ratio evaluates how efficiently the assets are used in earning income from operations. So, ROI is a tool used to measure and compare the performance of a units or divisions or a companies.
Formula of ROI according to Dupont formula:
Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.
To determine: Profit margin, investment turnover, and return on investment of C Division
Explanation of Solution
Determine ROI of C Division, if income from operations is $420,000, sales are $3,500,000, and assets invested are $2,500,000.
(2)
To prepare: The income statements for C Division of Company M for the year ended December 31, for each of the three proposals, and compute invested assets for each proposal.
Explanation of Solution
Prepare divisional income statements for C Division of Company M for the year ended December 31, for the three proposals.
Company M | |||
Divisional Income Statements | |||
For the Year Ended December 31 | |||
Proposal 1 | Proposal 2 | Proposal 3 | |
Sales | $3,500,000 | $3,500,000 | $2,905,000 |
Cost of goods sold | 2,585,000 | 1,920,000 | 2,073,300 |
Gross profit | 915,000 | 1,580,000 | 831,700 |
Operating expenses | 600,000 | 600,000 | 425,000 |
Income from operations | $315,000 | $980,000 | $406,700 |
Table (1)
Working Notes:
Compute cost of goods sold under proposal 1.
Compute cost of goods sold under proposal 2.
Compute sales under proposal 3.
Compute cost of goods sold under proposal 3.
Compute operating expenses under proposal 3.
(3)
Explanation of Solution
1)
Determine ROI of C Division, under proposal 1, if income from operations is $315,000, sales are $3,500,000, and assets invested are $2,187,500.
Note: Refer to part (1) for the values of income from operations and invested assets.
2)
Determine ROI of C Division, under proposal 2, if income from operations is $980,000, sales are $3,500,000, and assets invested are $4,375,000.
Note: Refer to part (1) for the values of income from operations and invested assets.
3)
Determine ROI of C Division, under proposal 3, if income from operations is $406,700, sales are $2,905,000, and assets invested are $1,162,000.
Note: Refer to part (1) for the values of income from operations and invested assets.
(4)
To indicate: The proposal which meets the desired ROI of 22.4%
Explanation of Solution
Proposal 3 meets desired ROI of 22.4% because the proposal has 35.0% ROI.
(5)
Explanation of Solution
Determine increase in investment turnover of C Division, if income from operations is $406,700 and sales are $2,905,000.
Step 1: Find the required investment turnover to earn desired ROI of 21%.
Step 2: Find the increase in investment turnover, if required investment turnover is 1.75 (From Step 1), and current investment turnover is 1.40 (From Part (1)).
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Chapter 23 Solutions
FINANCIAL & MANAGERIAL ACCT LOOSE LEAF
- Effect of proposals on divisional performance A condensed income statement for the Commercial Division of Maxell Manufacturing Inc. for the year ended December 31, 20Y9, is as follows: Assume that the Commercial Division received no allocations from support departments. The president of Maxell Manufacturing has indicated that the divisions return on a 2,500,000 investment must be increased to at least 21% by the end of the next year if operations are to continue. The division manager is considering the following three proposals: Proposal 1: Transfer equipment with a book value of 312,500 to other divisions at no gain or loss and lease similar equipment. The annual lease payments would exceed the amount of depreciation expense on the old equipment by 105,000. This increase in expense would be included as part of the cost of goods sold. Sales would remain unchanged. Proposal 2: Purchase new and more efficient machining equipment and thereby reduce the cost of goods sold by 560,000 after considering the effects of depreciation expense on the new equipment. Sales would remain unchanged, and the old equipment, which has no remaining book value, would be scrapped at no gain or loss. The new equipment would increase invested assets by an additional 1,875,000 for the year. Proposal 3: Reduce invested assets by discontinuing a product line. This action would eliminate sales of 595,000, reduce cost of goods sold by 406,700, and reduce operating expenses by 175,000. Assets of 1,338,000 would be transferred to other divisions at no gain or loss. Instructions 1. Using the DuPont formula for return on investment, determine the profit margin, investment turnover, and return on investment for the Commercial Division for the past year. 2. Prepare condensed estimated income statements and compute the invested assets for each proposal. 3. Using the DuPont formula for return on investment, determine the profit margin, investment turnover, and return on investment for each proposal. Round the investment turnover and return on investment to one decimal place. 4. Which of the three proposals would meet the required 21% return on investment? 5. If the Commercial Division were in an industry where the profit margin could not be increased, how much would the investment turnover have to increase to meet the presidents required 21% return on investment?arrow_forwardDivisional performance analysis and evaluation The vice president of operations of Free Ride Bike Company is evaluating the performance of two divisions organized as investment centers. Invested assets and condensed income statement data for the past year for each division are as follows: Instructions 1. Prepare condensed divisional income statements for the year ended December 31, 20Y7, assuming that there were no support department allocations. 2. Using the DuPont formula for return on investment, determine the profit margin, investment turnover, and return on investment for each division. Round percentages and the investment turnover to one decimal place. 3. If managements minimum acceptable return on investment is 10%, determine the residual income for each division. 4. Discuss the evaluation of the two divisions, using the performance measures determined in parts (1), (2), and (3).arrow_forwardService department charges In divisional income statements prepared for Demopolis Company, the Payroll Department costs are charged back to user divisions on the basis of the number of payroll distributions, and the Purchasing Department costs are charged back on the basis of the number of purchase requisitions. The Payroll Department had expenses of 64,560, and the Purchasing Department had expenses of 40,000 for the year. The following annual data for Residential, Commercial, and Government Contract divisions were obtained from corporate records: A. Determine the total amount of payroll checks and purchase requisitions processed per year by the company and each division. B. Using the cost driver information in (A), determine the annual amount of payroll and purchasing costs allocated to the Residential, Commercial, and Government Contract divisions from payroll and purchasing services. C. Why does the Residential Division have a larger support department allocation than the other two divisions, even though its sales are lower?arrow_forward
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