Question #2 (50%)

Slugger Corporation produces baseball bats for kids that it sells for $36 each. At capacity, the company can
produce 50,000 bats a year. The costs of producing and selling 50,000 bats are as follows:

Cost per bat Total costs

Direct Materials $13 $ 650,000
Direct Manufacturing Labor 5 250,000
Variable Manufacturing Overhead 2 100,000
Fixed Manufacturing Overhead 6 300,000
Variable Selling Expenses 3 150,000
Fixed Selling Expenses 2 100,000
Total Costs 31 1,550,000

Required.
1. Suppose Slugger is currently producing and selling 40,000 bats. At this level of production and sales, its
fixed costs are the same as given in the preceding table. Bench corporation wants to place a one-time
special order for 10,000 bats at $23 each. Slugger will incur no variable selling costs for this special order.
Should Slugger accept this one-time special order? Show your calculations. (idle cap)
2. Now suppose Slugger is currently producing and selling 50,000 bats. If Slugger accepts Bench’s offer it will
have to sell 10,000 fewer bats to its reguler customer. (full cap)
a. On financial considerations alone, should Slugger accept this one-time special order? Show your
calculations.
b. On financial considerations alone, at what price would Slugger be indifferent between accpeting the
special order and continuing to sell to its reguler customers at $36 per bat
c. What other factors shoule Slgger consier in decising whether to accept the one-time special order?

Problem 5
11-29 (20 min.) Special Order3

1.
Revenues from special order ($23  10,000 bats) $230,000
Variable manufacturing costs ($201  10,000 bats) (200,000)
Increase in operating income if Bench order accepted $ 30,000
1
Direct materials cost per unit + Direct manufacturing labor cost per unit + Variable manufacturing overhead
cost per unit = $13 + $5 + $2 = $20

idle cap (50rb – 40rb) = 10rb

klo idle adalah 8rb special order 10rb

Slugger should accept Bench’s special order because it increases operating income by $30,000. Because no
variable selling costs will be incurred on this order, this cost is irrelevant. Similarly, fixed costs are irrelevant
because they will be incurred regardless of the decision.

2a. Revenues from special order ($23  10,000 bats) $230,000

Variable manufacturing costs ($20  10,000 bats) (200,000)
Contribution margin foregone (ngedrop regular (130,000)
customer) ([$36─$231]  10,000 bats)
Decrease in operating income if Bench order accepted $(100,000)
1
Direct materials cost per unit + Direct manufacturing labor cost per unit + Variable manufacturing overhead
cost per unit + Variable selling expense per unit = $13 + $5 + $2 + $3 = $23
Based strictly on financial considerations, Slugger should reject Bench’s special order because it results in a
$100,000 reduction in operating income.

2b. Slugger will be indifferent between the special order and continuing to sell to regular customers if the
special order price is $33. At this price, Slugger recoups the variable manufacturing costs of $200,000 and the
contribution margin given up from regular customers of $130,000 ([$200,000 + $130,000] ÷ 10,000 units =
$33). That is, at the special order price of $33, Slugger recoups the variable cost per unit of $20 and the
contribution margin per unit given up from regular customers of $13 per unit.
 An alternative approach is to recognize that Slugger needs to earn $100,000 more than the revenues of
$230,000 in requirement 2a, so that the decrease in operating income of $100,000 becomes $0. Slugger will be
indifferent between the special order and continuing to sell to regular customers if revenues from the special
order = $230,000 + $100,000 = $330,000 or $33 per bat ($330,000  10,000 bats)
Looked at a different way, Slugger needs to earn the full price of $36 less the $3 saved on variable
selling costs.

2c. Slugger may be willing to accept a loss on this special order if the possibility of future long-term sales
seem likely at a higher price. Moreover, Slugger should also consider the negative long-term effect on customer
relationships of not selling to existing customers. Slugger cannot afford to sell bats to customers at the special
order price for the long term because the $23 price is less than the full manufacturing cost of the product of
$26. This means that in the long term, the contribution margin earned will not cover the fixed costs and result
in a loss. Slugger will then be better off shutting down.

Question #1 (20%)
PT ABC has a number of divisions, including Components Division and Goods Division. The
Components Division produces a part that is used by the Goods Division. The cost of manufacturing
the part is as follows:

Direct Materials $10

Direct Labor 2
Variable Overhead 3
Fixed Overhead (based on a practical capacity of 200.000 parts) 5
Total Cost $20

Other costs incurred by the Components Division are as follows:

Fixed Selling and Admin Expense $500,000
Variable selling expense $1 per unit

The part usually sells for between $28 and $30 in the external market. Currently, the Components
Division is selling it to external customers for $29. The division is capable of producing 200,000 units
of the part per year; however, because of a weak economy, only 150,000 pats are expected to sold
internally. (idle capacity)

The Goods Division has been buying the same part from an external supplier for $28. It expects to
use 50.000 units of the part during the coming year. The manager of the Goods Division has offered to
buy 50,000 units from the Components Division for $18 per unit.

Required:
1. Determine the minimum transfer price that the Components Division would accepts. $15
2. Determine the minimum transfer price that the manager of the Goods Division would pay.
3. Should an internal transfer take place? Why or why not? Offered $18
4. If you were the manager of the Components Division, would you sell the 50.000 components for
$18 each? Explain.
5. Suppose that the average operating asset of the Component Division total $10million. Compute the
ROI for the coming year, assuming that the 50.000 units are transferred to the Goods Division for
$21 each.

Solutions:
1. The required transfer price is $15 (all the variable cost = $10 + $2 +$3).
The Components Division has idle capacity and so must cover only its incremental costs, which are
the variable manufacturing costs. (Fixed costs are the same whether or not the internal transfer
occurs; the variable selling expenses are avoidable)
2. The maximum transfer price is $28. The Goods Division would not pay more for the part than the
price it would have to pay an external supplier. (market price)
3. Yes. An internal transfer ought to occur; the opportunity cost of the selling division is less than the
opportunity cost of the buying division.
4. The Components Division would earn an additional $150.000 profit ($3 x 50.000). The total joint
benefit, however, is $650.000 ($13 x 50.000). The manager of the Components Division should
attempt to negotiate a more favorable outcome for that division. Good division earn additional
($10 x 50,000) (28-18)
5. Income Statement: component departemen
Sales ($29 x 150.000) + ($21 X 50.000) $5.400.000
Less:
Variable Cost of Goods Sold ($15 x 200.000) 3.000.000
Variable Selling Expense ($1 x 150.000) 150.000
Contribution Margin $2.250.000
Less:
Fixed Overhead ($55 x 200.000) 1.000.000
Fixed Selling and administrative 500.000
Operating Income $ 750.000

ROI = Operating Income / Average Operating Assets

= $750.000/$10.000.000 = 0.075 or 7.5%
Question #2 (20%)
PT ABC is a subsidiary of ABC International. ABC International is asking PT ABC to expand.
Shareholders of PT DEF is considering to sell the company. ABC International believes that the assets
of PT DEF can be acquired for $3,2 million and urge Mr. XX, the CEO of PT ABC to acquire PT DEF.

Mr. XX had analyzed PT DEF financial reports with Mrs. YY, the CFO, and they believe that acquiring
PT DEF is not the right decision for PT ABC. ABC International used Return on Investment (ROI),
calculated as the ratio of operating income to total assets, to evaluate all subsidiaries. ABC
International required a minimum 20% ROI. Bonus will be given to subsidiaries that can increase ROI;
others should provide convincing explanation before they can be eligible for a bonus at a maximum
50%.

Financial data for PT ABC and PT DEF as follows:

PT ABC PT DEF
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 Asset 2,300,000 1,900,000

Long term Asset 5,700,000 1,100,000
Total Aset s 8,000,000 3,000,000
Current Liabilities 1,400,000 850,000
Long term Liabilities 3,800,000 1,200,000
Equity 2,800,000 950,000
Liability and Equity 8,000,000 3,000,000

Required:
1. If ABC International continues to use ROI as the sole measure of subsidiaries performance,
explain why PT ABC would be reluctant to acquire PT DEF. Be sure to support your answer
with appropriate calculations.
2. If ABC International could be persuaded to use residual income to measure the performance of
PT ABC, explain why PT ABC would be more willing to acquire PT DEF. Be sure to support your
answer with appropriate calculations.
3. Discuss how the behavior of subsidiaries managers is likely to be affected by the use of:
a. ROI as a performance measures
b. Residual income as a performance measures

1. If Mason Industries continues to use return on investment as the sole measure of division
performance, JSC would be reluctant to acquire RLI because the combined return on investment
would decrease.
ABC return on investment = $2,000,000/$8,000,000 = 0.2500 = 25%
DEF return on investment = $600,000/$3,200,000* = 0.1875 = 18,75%
Combined return on investment = $2,600,000/$11,200,000 = 0.2321 =23,21%
*Note that the asset cost used for DEF is the post-acquisition cost of $3,200,000, not the pre-
acquisition value of assets.
 This would result in ABC managers either losing or having their bonuses limited to 50 percent of
the eligible amounts, which assumes management could provide convincing explanations for the
decline in ROI.

2. If Mason Industries could be persuaded to use residual income to measure performance, JSC
would be more willing to acquire RLI because the residual income of the combined operation
would be larger than the residual income for JSC alone.
JSC = ABC residual income = $2,000,000 – ($8,000,000 × 0.15) = $800,000
RLI = DEF residual income = $600,000 – ($3,200,000 × 0.15) = $120,000
Combined residual income = $800,000 + $120,000 = $920,000

3. The likely effect on the behavior of division managers whose performance is measured by:

a. Return on investment includes considerations to: put off capital improvements or

modernization to avoid capital expenditures, and shy away from profitable opportunities or
investment that would yield more than the company’s cost of capital but which may lower
overall ROI.
b. Residual income includes considerations to: seek any opportunity or investment that will
earn more than the cost of capital target rate, and seek to reduce the level of assets employed
in the business.