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Problem No. 1: The operating result of three divisions of X Ltd.

is given below: Particulars Divisions A B C Sales 400000 400000 2000000 Less: Expenses 360000 200000 1800000 Segment profit contribution 40000 200000 200000 Segment assets 200000 800000 4000000 Determine the rate of return for these three divisions and rank these divisions assuming that company follows investment center basis of performance evaluation. Solution: Rate of return of divisions Particulars Sales Less: Expenses Segment profit contribution Segment assets Profit Margin = Profit / Sales x100 Assets Turnover (Sales / Assets) x 100 Segment rate of return % = Profit Margin X Assets T/O Comments: A 400000 360000 40000 200000 10% 2 20 Divisions B 400000 200000 200000 800000 50% 0.50 25

C 2000000 1800000 200000 4000000 10% 0.50 5

In absolute terms, segment profit contributions are similar (Rs. 2 lakh) for division B and C. However, in relative terms, division B performance is far batter than division C and the respective figures for profit margin being 50% and 10%. The segment rate of return of Division B is higher than that of C. Although A and C both have 10% as profit margin, A earned a 20% Return on investment as compared to Cs 5% because the assets turnover ratio of A is 2 times, whereas that of C is only 0.50. Based on their segment rate of return on investment, the three would be ranked B- 1st, A 2nd, C 3rd. Problem No. 2 The operating results of a manufacturing company for the current year are given below: Particulars Sales (40000 units) Less: Trade discount Net sales Less: Cost of sales Material Labor Factory overheads Administrative overheads Selling and dist. Total Cost Profit Amount (Lakhs) 480 24 456 144 126 63 36 45 414 42

The following changes are anticipated during next year: (a) (b) (c) (d) Units to be sold to increase by 25%. Material price to increase by 15%. Labor charges to increase by 12%. Overheads- factory overheads will be limited to 65 lakhs , administrative and selling and distribution overheads are estimated to increase by 10% and 15% respectively. (e) Profit target for the year is Rs. 60 lakhs. Calculate the selling price and present the budgeted operating results, for the next year. Solution: (a) Budgeted operating Income Statement Particulars Sales (50000 units) Less: Trade discount (5%) Net sales Less: Variable Cost Material Labor Contribution Less: Factory overheads Factory Administrative Selling & Dist Net profit (b) Calculation of selling price Particulars Net profit estimated Additional profit desired Profit desired Contribution required (186.6 + 29.75) Add: Variable Cost Net sales Add: Trade discount Gross sales Selling Price Per Unit (63132000 / 50000) Problem No. 3: You are furnished with the following data relating to Arvind Ltd. Centers Cash & Bank Inventories Receivable Fixed Assets Profit A 10 20 30 90 30 B 15 20 25 65 12.5 C 05 10 20 50 8.5 The corporate cost of capital of capital relating to money invested in receivables and debtors is 6% post tax. The rate of return required by the company for investing in fixed assets is 9% post tax. Calculate the ROI and EVA from the above data and show the difference between the two methods of investment center evaluation. Amount (Lakhs) 30.25 29.75 60.00 216.35 383.40 599.75 31.57 631.32 1262.64 Amount (Lakhs) 600 30 570 207 176.4 186.60 65 39.60 51.57 30.25

Solution: (a) Calculation of ROI Centers A B C Cash Bank 10 15 05 & Inventories 20 20 10 Receivable 30 25 20 Fixed Assets 90 65 50 Total Investment 150 125 85 360 Budgeted Profit 30 12.5 8.5 51 ROI % 20 10 10 14.16

While calculating ROI show calculation in respective column of ROI, show formula below Table (b) Calculation of EVA Centers Profit Current WACC Assets Required Earnings (C.A X WACC) (4) 3.6 3.6 2.1 9.3 Fixed Assets WACC Required EVA Earnings (F.A X WACC) (7) (8) = (1) (4 + 7) 8.10 18.30 5.85 3.05 4.50 1.90 18.45 23.25

A B C

(1) 30 12.5 8.5 51

(2) 60 60 35

(3) 6% 6% 6%

(5) 90 65 50

(6) 9% 9% 9%

EVA = Profits (CA X WACC + FA X WACC) A =30 (3.6 + 8.10) = 18.3 Lakhs B =12.5 (3.6 + 5.85) = 3.05 Lakhs C =8.5 (2.1 + 4.50) = 1.9 Lakhs Total EVA of Company = Profit Capital Carges = 51 23.25 = 27.75 Lakhs Comments: There is no consistency between the ROI objective and cutoff rate in any of the investment center. The actual EVA can be calculated and compared with the budgeted EVA. Thus, it is worthwhile noting that if any investment center earns more than 9% on fixed assets and 6% on current assets, its EVA will increase. This will make the financial decision rules of the investment center consistent with those of the company.

Problem No. 4: A company has two divisions A nad B which are operated as profit centers. Division A has been selling a part of its production to the division B at Rs. 200 per unit. Annual output of division A is 10000 units. Sales are made as follows: Division B Outside customer Unit cost of Division A is as follows: Fixed cost Variable Cost Total Cost Rs. 75 per unit Rs. 100 per unit Rs. 175 per unit 4000 units 6000 units

Division B has found that it can negotiate a contract to buy from outside suppliers at Rs. 150 per unit. Should division B be allowed to purchase from outside? Can you suggest an alternative in this respect? Solution: Cash Flows Total Purchase cost (4000 x 150) Total cash outlay (4000 x 100) Fixed Cost (4000 x 75) Total Cash Outflow of company Buy from outside Rs. 600000 ---Rs. 300000 Rs. 900000 Buy from Division B ---Rs. 400000 Rs. 300000 Rs. 700000

From the above calculation it is clear that company make total profit of Rs. 20000o if it buys form Division B. So, it is suggestible that company should buy from outside (Note: just expand this by putting more comments)

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