RETURN ON INVESTMENT

Return on Investment Computation

Based on Operating Income
1. The following selected data pertain to the belt division of Allen Corp. for last year:
Sales $500,000
Average operating assets $200,000
Net operating income $80,000
Turnover 2.5
Minimum required return 20%
How much is the return on investment? (M)
a. 40% c. 20%
b. 16% d. 15% AICPA, Adapted

2. Harstin Corporation has provided the following data:

Sales $625,000
Gross margin 70,000
Net operating income 50,000
Stockholders' equity 90,000
Average operating assets 250,000
Residual income 20,000
The return on investment for the past year was: (M)
a. 28%. c. 36%.
b. 20%. d. 8%. G & N 9e

Investment
3. Apple Division of the American Fruit Co. had the following statistics for 2002:
Assets available for use $1,000,000
Residual income 100,000
Return on investment 15%
If the manager of Apple Division is evaluated based on return on investment, how much
would she be willing to pay for an investment that promises to increase net segment income
by $50,000? (M)
a. $50,000 c. $1,000,000
b. $333,333 d. $500,000 Barfield

Required Peso Sales

4. The manager of the Strong Division of Powers Company expects the following results
in 2003 (pesos in millions);
Sales P49.60
Variable costs (60%) 29.76
Contribution margin P19.84
Fixed costs 12.00
Profit P 7.84
Investment
Plant equipment P19.51
Working capital 14.88 P34.39
ROI (P7.84/P34.39) 22.80%
The division has a target ROI of 30%, and the manager has asked you to determine how much
sales volume the division would need to reach. He states that the sales mix is relatively
constant so variable costs should be close to 60% of sales, fixed cost and plant and equipment
should remain constant, and working capital (cash, receivables and inventories) should vary
closely with sales in the percentage reflected above.
The peso sales that the division needs in order to reach the 30% ROI target is (D)
A. P19,829,032. C. P44,373,871
B. P57,590,322 D. P59,510,000 Pol Bobadilla

Dupont Model
Sensitivity Analysis
5. If the operating income margin of 0.3 stayed the same and the operating asset
turnover of 5.0 increased by 10 percent, the ROI (M)
a. increase by 10 percent d. remain the same
b. decrease by 10 percent e. increase to 1.5.
c. increase by 15 percent H&M

6. If the investment turnover increased by 20% and ROS decreased by 30%, the ROI
would (M)
a. Increase by 20%. c. Increase by 4%.
b. Decrease by 16%. d. None of the above. D, L & H 9e

7. If the investment turnover decreased by 20% and ROS decreased by 30%, the ROI
would (M)
a. Increase by 30%. c. Decrease by 44%.
b. Decrease by 20%. d. None of the above. D, L & H 9e
8. Company L had its operating asset turnover increased by 50% and the operating
income margin increased by 50%. Company U had its operating asset turnover increased by
30% and the operating income margin decreased by 30%. What changes are expected for ROI
of Company L and Company U, respectively? (M)

Pol Bobadilla A. B. C. D.
Company L 50% increase 125% increase 225% increase 125% increase
Company U 9% decrease 9% decrease No change No change

RESIDUAL INCOME
Residual Income Computation
9. REB Service Co. is a computer service center. For the month of May 1995, REB had the
following statistics:
Sales $450,000
Operating income 25,000
Net profit after taxes 8,000
Total assets 500,000
Shareholders equity 200,000
Cost of capital 6%
Based on the above information, which one of the following statements is correct? REB has a
(M)
a. ROI of 4% c. ROI of 1.6% CMA 0695 3-20
b. Residual income of $(5,000) d. Residual income of $(22,000)

Target Cost
10. James Webb is the general manager of the Industrial Park Division, and his
performance is measured using the residual income method. Webb is reviewing the
following forecasted information for the division for next year.

Category Amount (thousands)

Working capital $ 1,800
Revenue 30,000
Plant and equipment 17,200
To establish a standard of performance for the divisions manager using the residual income
approach, four scenarios are being considered. Scenario 1 assumes an imputed interest
charge of 15% and a target residual income of $2,000,000. Scenario 2 assumes an imputed
interest charge of 12% and a target residual income of $1,500,000. Scenario 3 assumes an
imputed interest charge of 18% and a target residual income of $1,250,000. Scenario 4
assumes an imputed interest charge of 10% and a target residual income of $2,500,000.
Which of the scenarios assumes the lowest maximum cost? (M)
a. Scenario 1. c. Scenario 3.
b. Scenario 2. d. Scenario 4. Gleim

RETURN ON INVESMENT, MINIMUM REQUIRED RATE OF RETURN & RESIDUAL INCOME

Minimum Required Rate of Return & Residual Income
Return on Investment
11. Fortree products have a residual net income of P1.8 million. If the imputed interest
rate is 16%, compute the ROI (M)
a. 5% c. 15%
b. 10% d. not listed RPCPA 1091

12. Z Division of XYZ Corp. has the following information for 2002:
Assets available for $1,800,000
Target rate of return 10%
Residual income $270,000
What was Z Division's return on investment for 2002? (M)
a. 15% c. 25%
b. 10% d. 20% Barfield

13. Pasta Division of We Make Italian, is evaluated based on residual income generated.
For 2002, the Division generated a residual income of $2,000,000 and net income of
$5,000,000. The target rate of return for all divisions of We Make Italian is 20 percent. For
2002, what was the return on investment for Pasta Division? (M)
a. 40% c. 20%
b. 13% d. 33% Barfield

Return on Investment, Minimum Required Rate of Return & Residual Income

Investment Cost
14. In the X Division of S Co., 2002 segment income exceeded 2002 residual income by
$15,000. Also for 2002, return on investment exceeded the target rate of return by 10
percent. What was the level of investment in the X Division for 2002? (M)
a. $15,000
b. $100,000
c. $150,000
d. An answer can't be determined from this information. Barfield
Return on Investment & Residual Income & Units Sold
Questions 15 thru 17 are based on the following information. G & N 9e
The Axle Division of LaBate Company makes and sells only one product. Annual data on the
Axle Division's single product follow:
Unit selling price $50
Unit variable cost $30
Total fixed costs $200,000
Average operating assets $750,000
Minimum required rate of return 12%

15. If Axle sells 16,000 units per year, the return on investment should be: (M)
a. 12%. c. 16%.
b. 15%. d. 18%.

16. If Axle sells 15,000 units per year, the residual income should be: (M)
a. $30,000. c. $50,000.
b. $100,000. d. $10,000. G & N 9e

17. Suppose the manager of Axle desires an annual residual income of $45,000. In order to
achieve this, Axle should sell how many units per year? (M)
a. 14,500. c. 18,250.
b. 16,750. d. 19,500. G & N 9e

ECONOMIC VALUE-ADDED
EVA Based on Operating Income
18. Division A had the following information:
Asset base in Division A $800,000
Net income in Division A $100,000
Operating income margin for Division A 20%
Target ROI 15%
Weighted-average cost of capital 12%
What is EVA for Division A?
a. $120,000 d. $4,000
b. $96,000 e. $(20,000)
c. $15,000 H&M
19. Watne Company has two divisions, M and N. Information for each division is as
follows:
Net earnings for division $65,000
Asset base for division $300,000
Target rate of return 18%
Operating income margin 20%
Weighted average cost of capital 12%
What is EVA for N?
a. $36,000 c. $54,000
b. $29,000 d. $11,000 H&M

20. Family Company has two divisions, Ma and Pa. Information for each division is as
follows:

Ma Pa
Net earnings for division P20,000 P65,000
Asset base for division P50,000 P300,000
Target rate of return 15% 18%
Operating income margin 10% 20%
Weighted-average cost of capital 12% 12%
What is the Economic Value Added for Ma and Pa, respectively?
A. P20,000, P36,000 C. P12,500; P11,000
B. P14,000; P29,000 D. P20,000; P29,000 Pol Bobadilla

EVA Based on Operating Income after Tax

EVA - Given Operating Income Before Tax
21. McKenzie Oil had $440,000 in operating income before interest and taxes in the last
year. McKenzie is in the 40% tax bracket. If capital employed by McKenzie was equal to
$300,000, and the company's weighted-average after-tax cost of capital is 15%, what is
McKenzie's Economic Value Added?
A. $131,000 C. $198,000
B. $140,000 D. $219,000 Gleim

22. Valecon Co. reported the following information for the year just ended:

Segment A Segment B Segment C

Pre-tax operating income $ 4,000,000 $ 2,000,000 $3,000,000
Current assets 4,000,000 3,000,000 4,000,000
Long-term assets 16,000,000 13,000,000 8,000,000
Current liabilities 2,000,000 1,000,000 1,500,000
If the applicable income tax rate and after-tax weighted-average cost of capital for each
segment are 30% and 10%, respectively, the segment with the highest economic value added
(EVA) is (M)
A. Segment A. C. Segment C. Gleim
B. Segment B. D. Not determinable from this information.

23. Assume Avionics Industries reported at year-end that operating income before taxes
for the year equaled $2,400,000. Long-term debt issued by Avionics has a coupon rate equal
to 6%, and its cost of equity is 8%. The book value of the debt currently equals its fair value,
and the book value of the equity capital for Avionics is $900,000 less than its fair value.
Current assets are listed at $2,000,000 and long-term assets equal $9,600,000. The claims
against those assets are in the form of $1,500,000 in current liabilities and $2,200,000 in long-
term liabilities. The income tax rate for Avionics is 30%. What is the economic value added
(EVA)? (D)
a. $731,240 c. $1,668,760
b. $948,760 d. $1,680,000 Gleim

Questions 24 thru 26 are based on the following information. Horngren

Waldorf Company has two sources of funds: long-term debt with a market and book value of
$10 million issued at an interest rate of 12%, and equity capital that has a market value of $8
million (book value of $4 million). Waldorf Company has profit centers in the following
locations with the following operating incomes, total assets, and total liabilities. The cost of
equity capital is 12%, while the tax rate is 25%.

Operating Income Assets Current Liabilities

St. Louis $ 960,000 $ 4,000,000 $ 200,000
Cedar Rapids $1,200,000 $ 8,000,000 $ 600,000
Wichita $2,040,000 $12,000,000 $1,200,000
24. What is the EVA for St. Louis? (M)
a. $255,740 c. $392,540
b. $327,460 d. $720,000

25. What is the EVA for Cedar Rapids? (M)

a. $135,580 c. $234,000
b. $220,000 d. $305,000
26. What is the EVA for Wichita? (M)
a. $450,000 c. $414,360
b. $1,530,000 d. $1,115,640

EVA Computation Given Operating Income after Tax

27. Samovar Company has operating income after taxes of $50,000. It has $200,000 of
equity capital, which has an after-tax weighted-average cost of 12%. Samovar also has
$10,000 of current liabilities (noninterest-bearing) and no long-term liabilities. What is the
company's economic value added (EVA) for the period?
A. $(24,000) C. $24,000
B. $(26,000) D. $26,000 Gleim

28. Ralph, an investor, is interested in loaning money to a secure corporation. He always

bases his decision on the company with the largest economic value added (EVA). Ralph has
narrowed his choices down to four, and has collected the following information:

Operating
Income after Tax
Equity Capital
WACC
Current Liabilities
Company A $50,000 $200,000 12% $10,000
Company B 60,000 150,000 20% 18,000
Company C 45,000 220,000 10% 30,000
Company D 55,000 250,000 15% 5,000
Based on largest EVA and assuming that none of the companies have any long-term liabilities,
which company should Ralph invest in?
A. Company A. C. Company C.
B. Company B. D. Company D. Gleim

Equity Value Creation, Market Value Added & Total Shareholder Return
Questions 29 thru 31 are based on the following information. Gleim
Semibar Co. reports net income of $630,000. The information below or the year just ended is
also available:

January 1 December 31
Shareholders equity $4,200,000 $4,480,000
Share price $25 $30
Shares outstanding 400,000 400,000
Cost of equity 10% 10%
Dividends per share $1.00

29. Equity value creation is

a. $630,000 c. $420,000
b. $448,000 d. $210,000

30. The market value added (MVA) is

a. $2,000,000 c. $400,000
b. $1,720,000 d. $280,000

31. The total shareholder return is

a. 24% c. 16.67%
b. 20% d. 4%

SENSITIVITY ANALYSIS
32. Apple Division of the American Fruit Co. had the following statistics for 2002:
Assets available for use $1,000,000
Residual income 100,000
Return on investment 15%
If expenses increased by $20,000 in Apple Division, (E)
a. return on investment would decrease. c. the target rate of return would
decrease.
b. residual income would increase. d. asset turnover would decrease.
Barfield

33. Division A had the following information:

Asset base in Division A $800,000
Net income in Division A $100,000
Operating income margin for Division A 20%
Target ROI 15%
Weighted-average cost of capital 12%
If the asset base is decreased by $200,000, with no other changes, the return on investment
of Division A will be
a. 100.0% d. 62.5%
b. 16.7% e. 20.0%
c. 600.0% H&M
Comprehensive
Questions 34 through 38 are based on the following information. AICPA 1186 II-22 to
26
Oslo Co.s industrial photo-finishing division, Rho, incurred the following costs and expenses
in 1992:

Variable Fixed
Direct materials $200,000
Direct labor 150,000
Factory overhead 70,000 $42,000
General, selling and administrative 30,000 48,000
Totals $450,000 $90,000

During 1992, Rho produced 300,000 units of industrial photo-prints, which were sold for
$2.00 each. Oslos investment in Rho was $500,000 and $700,000 at January 1, 1992 and
December 31, 1992, respectively. Oslo normally imputes interest on investments at 15% of
average invested capital.

34. For the year-ended December 31, 1992, Rhos return on average investment was
a. 15.0% c. 8.6%
b. 10.0% d. (5.0%)

35. Assume that net operating income was $60,000 and that average invested capital was
$600,000. For the year ended December 31, 1992, Rhos residual income (loss) was
a. $150,000 c. $(45,000)
b. $60,000 d. $(30,000)

36. How many industrial photo-print units did Rho have to sell in 1992 to break-even?
a. 180,000 c. 90,000
b. 120,000 d. 60,000

37. For the year ended December 31, 1992, Rhos contribution margin was
a. $250,000 c. $150,000
b. $180,000 d. $60,000
38. Assume the variable cost per unit was $1.50. Based on Rhos 1992 financial data, and
an estimated 1993 production of 350,000 units of industrial photo-prints, Rhos estimated
1993 total costs and expenses will be
a. $525,000 c. $615,000
b. $540,000 d. $630,000
Questions 39 through 51 are based on the following information. Gleim

Segment A Segment B Segment C Segment D

Net income $ 5,000 - - $ 90,000
Sales 60,000 $750,000 $135,000 1,800,000
Investment 24,000 500,000 45,000 -
Net income as % of sales - - - -
Turnover of investment - - - -
ROI - - 20% 7.5%
Minimum ROI-dollars - - - $120,000
Minimum ROI - % 20% 6% - -
Residual income - -0- $2,250 -

39. For Segment B, net income as a percentage of sales is

a. 8% c. 4%
b. 6.67% d. 10%

40. For Segment C, net income as a percentage of sales is

a. 5% c. 4%
b. 6.67% d. 20%

41. For Segment C, the turnover of investment is

a. 3 c. 2.5
b. 1.5 d. 4

42. For Segment D, the turnover of investment is

a. 3 c. 2.5
b. 1.5 d. 4

43. For segment A, ROI is

a. 6% c. 20.8%
b. 20% d. 7.5%
44. For segment B, ROI is
a. 6% c. 20%
b. 20.8% d. 7.5%

45. For segment A, the minimum dollar ROI is

a. $30,000 c. $4,800
b. $6,750 d. $120,000

46. For Segment B, the minimum dollar ROI is

a. $30,000 c. $4,800
b. $6,750 d. $120,000

47. For Segment C, the minimum dollar ROI is

a. $30,000 c. $4,800
b. $6,750 d. $120,000

48. Assume that the minimum dollar ROI is $6,750 for Segment C. The minimum
percentage of ROI is
a. 20% c. 15%
b. 6% d. 10%

49. In Segment D, the minimum percentage of ROI is

a. 20% c. 15%
b. 6% d. 10%

50. In Segment A, the residual income is

a. $200 c. $(30,000)
b. $12,000 d. $4,800

51. In Segment D, the residual income is

a. $12,000 c. $(60,000)
b. $(30,000) d. $9,000

SEGMENTED INCOME STATEMENT

Sales
52. During April, Division D of Carney Company had a segment margin ratio of 15%, a variable
expense ratio of 60% of sales, and traceable fixed expenses of $15,000. Division D's sales
were closest to: (M)
a. $100,000. c. $33,333.
b. $60,000. d. $22,500. G & N 9e

Segment Margin
53. Assume the following information for a product line:
Sales revenue $500,000
Variable manufacturing costs 100,000
Direct fixed manufacturing costs 75,000
Variable selling/administrative costs 50,000
Direct fixed selling/admin. costs 60,000
What is the segment margin of the product line? (E)
a. $400,000 d. $275,000
b. $325,000 e. $215,000
c. $350,000 H&M

54. The data available for the current year are given below:

Whole Co. Division 1 Division 2

Variable mfg. cost of goods sold $ 400,000 $ 220,000 $ 80,000
Unallocated costs (e.g., presidents salary) 100,000 - -
Fixed costs controllable by Div. Managers 90,000 50,000 40,000
(e.g., advertising, engg supervision costs)
Net revenue 1,000,000 600,000 400,000
Variable selling and administrative costs 130,000 70,000 60,000
Fixed costs controllable by others (e.g., depreciation, insurance)
120,000
70,000
50,000
Using the information presented above, the contribution by Division 1 was (M)
a. $190,000 c. $310,000
b. $260,000 d. $380,000 CIA 1186 IV-17

55. A and B are autonomous divisions of a corporation. They have no beginning or ending
inventories, and the number of units produced is equal to the number of units sold.
Following is financial information relating to the two divisions.

A B
Sales $150,000 $400,000
Other revenue 10,000 15,000
Direct materials 30,000 65,000
Direct labor 20,000 40,000
Variable factory overhead 5,000 15,000
Fixed factory overhead 25,000 55,000
Variance S&A expense 15,000 30,000
Fixed S&A expense 35,000 60,000
Central corporate expenses (allocated) 12,000 20,000
What is the total contribution to corporate profits generated by Division A before allocation
of central corporate expenses? (M)
a. $18,000 c. $30,000
b. $20,000 d. $80,000 CIA 1193 IV-20

Common Fixed Costs

56. Lyons Company consists of two divisions, A and B. Lyons Company reported a
contribution margin of $50,000 for Division A, and had a contribution margin ratio of 30% in
Division B, when sales in Division B were $200,000. Net income for the company was $25,000
and traceable fixed expenses were $40,000. Lyons Company's common fixed expenses were:
(M)
a. $85,000. c. $45,000.
b. $70,000. d. $40,000. G & N 9e

Company Net Income

57. Redding Company has two divisions with the following segment margins for the
current year: Northern, $200,000; Southern, $400,000. Common expenses of the company are
$50,000. What is Redding Companys net income? (E)
a. $150,000 d. $650,000
b. $550,000 e. $350,000
c. $600,000 H&M

Comprehensive
Questions 58 & 59 are based on the following information. H&M
Barmore Company has the following information pertaining to its two divisions for 1995:

Division A Division B
Variable selling & administrative expenses $ 35,000 $ 45,000
Direct fixed manufacturing expenses 17,500 50,000
Sales 100,000 200,000
Direct fixed selling/admin. Expenses 15,000 35,000
Variable manufacturing expenses 20,000 50,000
Common expenses are $12,000 for 1995.

58. Common expenses are $12,000 for 1995. What is the segment margin for Division B?
(E)
a. $155,000 d. $20,000
b. $105,000 e. $8,000
c. $55,000

59. What is the net income for the Barmore Company? (E)
a. $300,000 d. $32,500
b. $162,500 e. $20,500
c. $150,000

Questions 60 & 61 are based on the following information. G & N 9e

Canon Company has two sales areas: North and South. During last year, the contribution
margin in the North Area was $50,000, or 20% of sales. The segment margin in the South was
$15,000, or 8% of sales. Traceable fixed costs are $15,000 in the North and $10,000 in the
South. During last year, the company reported total net income of $26,000.

60. The variable costs for the South Area for the year were: (M)
a. $230,000. c. $162,500.
b. $185,000. d. $65,000.

61. The total fixed costs (traceable and common) for Canon Company for the year were:
(M)
a. $49,000. c. $24,000.
b. $25,000. d. $50,000.

Questions 62 thru 64 are based on the following information. H&M

Nauman Company has the following information pertaining to its two divisions for 1995:

Division X Division Y
Variable selling & administrative expenses $ 70,000 $ 90,000
Direct fixed manufacturing expenses 35,000 100,000
Sales 200,000 400,000
Direct fixed selling/admin. expenses 30,000 70,000
Variable manufacturing expenses 40,000 100,000
Common expenses are $24,000 for 1995.

62. What is the net income for the Nauman Company? (E)
a. $600,000 d. $65,000
b. $325,000 e. $41,000
c. $300,000

63. What is the segment margin for Division X? (E)

a. $90,000 d. $160,000
b. $25,000 e. $125,000
c. $1,000
64. What is the segment margin for Division Y? (E)
a. $310,000 d. $40,000
b. $210,000 e. $16,000
c. $110,000

Questions 65 thru 68 are based on the following information. G & N 9e

Ieso Company has two stores: J and K. During November, Ieso Company reported a net
income of $30,000 and sales of $450,000. The contribution margin in Store J was $100,000, or
40% of sales. The segment margin in Store K was $30,000, or 15% of sales. Traceable fixed
expenses are $60,000 in Store J, and $40,000 in Store K.

65. Sales in Store J totaled: (M)

a. $400,000. c. $150,000.
b. $250,000. d. $100,000.

66. Variable expenses in Store K totaled: (M)

a. $70,000. c. $200,000.
b. $110,000. d. $130,000.

67. The segment margin ratio in Store J was: (M)

a. 16%. c. 40%.
b. 24%. d. 60%.

68. Ieso Company's total fixed expenses for the year were: (M)
a. $40,000. c. $140,000.
b. $100,000 d. $170,000.
Sensitivity Analysis
Questions 69 through 72 are based on the following information. CIA 1196 III-97 to 100
The segmented income statement for a retail company with three product lines is presented
below:

Total Company Product

Line 1 Product
Line 2 Product
Line 3
Volume (in units) 20,000 28,000 50,000
Sales revenue $2,000,000 $800,000 $700,000 $500,000
Costs & expenses:
Administrative $ 180,000 $ 60,000 $ 60,000 $ 60,000
Advertising 240,000 96,000 84,000 60,000
Commissions 40,000 16,000 14,000 10,000
Cost of sales 980,000 360,000 420,000 200,000
Rent 280,000 84,000 140,000 56,000
Salaries 110,000 54,000 32,000 24,000
Total costs & expenses $1,830,000 $670,000 $750,000 $410,000
Operating income (loss) $ 170,000 $130,000 $(50,000) $ 90,000
The company buys the goods in the three product lines directly from manufacturers'
representatives. Each product line is directed by a manager whose salary is included in the
administrative expenses. Administrative expenses are allocated to the three product lines
equally because the administration is spread evenly among the three product lines. Salaries
represent payments to the workers in each product line and therefore are traceable costs of
each product line. Advertising promotes the entire company rather than the individual
product lines. As a result, the advertising is allocated to the three product lines in proportion
to the sales revenue. Commissions are paid to the salespersons in each product line based on
2% of gross sales. Rent represents the cost of the retail store and warehouse under a lease
agreement with 5 years remaining. The product lines share the retail and warehouse space,
and the rent is allocated to the three product lines based on the square footage occupied by
each of the product lines.

69. The segmented income statement for this retail company does not facilitate
performance evaluation because it does not distinguish between controllable and
uncontrollable costs. The only costs and expenses controllable at the product-line level for
this retail company are (M)
A. Commissions, cost of sales, and rent. C. Commissions, cost of sales, and
salaries.
B. Advertising, cost of sales, and salaries. D. Administration, advertising, and
rent.

70. The company has an opportunity to promote one of its product lines by making a one-
time $7,000 expenditure. The company can choose only one of the three product lines to
promote. The incremental sales revenue that would be realized from this $7,000 promotion
expenditure in each of the product lines is estimated as follows:

Increase in Sales Revenue

Product Line 1 $15,000
Product Line 2 20,000
Product Line 3 14,000
In order to maximize profits, the promotion expenditure should be spent on <List A>,
resulting in an increase in operating income of <List B>. (M)

A. B. C. D.
List A Product Line 2 Product Line 2 Product Line 3 Product Line 3
List B $13,000 $5,000 $1,400 $1,120

71. One company executive has expressed concern about the operating loss that has
occurred in Product Line 2 and has suggested that Product Line 2 be discontinued. If Product
Line 2 is dropped, the manager of the line would be retained and assigned other duties with
the company, but the other employees would not be retained. Management has indicated
that the nature of the company's advertising might change with the elimination of Product
Line 2, but the total dollar amount would not change. If Product Line 2 were to be dropped,
the operating income of the company would (M)
A. Increase by $50,000. C. Decrease by $234,000.
B. Decrease by $94,000. D. Increase by $416,000.

72. A customer, operating in an isolated foreign market, has approached the head
salesperson for Product Line 1 and offered to purchase 4,000 units of a special-order product
over the next 12 months. This product would be sold in the same manner as Product Line 1's
other products except that the customer is hoping for a price break. Product Line 1's cost to
purchase this product (cost of sales) would be $14.70. Product Line 1 has excess capacity,
meaning that the rate or amount of the remaining operating costs would not change as a
consequence of the purchase and sale of this special-order product. The minimum selling
price for this special-order product would be (M)
A. $15.00 C. $27.50
B. $17.30 D. $30.20

SPECIAL ORDER
Operating at Full Capacity
Effect on Profit
73. Ajax Division of Carlyle Corporation produces electric motors, 20% of which are sold to
Bradley Division of Carlyle and the remainder to outside customers. Carlyle treats its
divisions as profit centers and allows division managers to choose their sources of sale and
supply. Corporate policy requires that all interdivisional sales and purchases be recorded at
variable cost as a transfer price. Ajax Divisions estimated sales and standard cost data for the
year ending December 31, 2000, based on the full capacity of 100,000 units, are as follows:
Bradley Outsiders
Sales $900,000 $8,000,000
Variable costs (900,000) (3,600,000)
Fixed costs (300,000) (1,200,000)
Gross margin $(300,000) $(3,200,000)
Unit sales 20,000 80,000
Ajax has an opportunity to sell the above 20,000 units to an outside customer at a price of
$75 per unit during 2000 on a continuing basis. Bradley can purchase its requirements from
an outside suppler at a price of $85 per unit.
Assuming that Ajax Division desires to maximize its gross margin, should Ajax take on the
new customer and drop its sales to Bradley for 2000, and why?
a. No, because the gross margin of the corporation as a whole would decrease by
$200,000.
b. Yes, because Ajax Divisions gross margin would increase by $300,000.
c. Yes, because Ajax divisions gross margin would increase by $600,000.
d. No, because Bradley Divisions gross margin would decrease by $800,000.

Operating with Excess Capacity

Minimum Price
74. Houston Division of Texacon, Inc. expects the following result for 2004:
Units sales 70,000
Units selling price P10
Unit variable cost P 4
Total fixed costs P300,000
Total investment P500,000
The minimum required ROI is 15%, and divisions are evaluated on residual income. A foreign
customer has approached Houstons manager with an offer to buy 10,000 units at P7 each. If
Houston accepts the order, it would not lose any of the 70,000 units at the regular price.
Accepting the order would increase fixed costs by P10,000 and investment by P40,000.
What is the minimum price that Houston could accept for the order and still maintain its
expected residual income?
A. P5.00 C.P4.75
B. P5.60 D. P9.00 Pol Bobadilla

Maximum Lost Units

75. Houston Division of Texacon, Inc. expects the following result for 2004:
Units sales 70,000
Units selling price P10
Unit variable cost P 4
Total fixed costs P300,000
Total investment P500,000
The minimum required ROI is 15%, and divisions are evaluated on residual income. A foreign
customer has approached Houstons manager with an offer to buy 10,000 units at P7 each. If
Houston accepts the order, it would not lose any of the 70,000 units at the regular price.
Accepting the order would increase fixed costs by P10,000 and investment by P40,000.
At the price of P7 offered by foreign customer, what is the maximum number of units in
regular sales that Houston could sacrifice and still maintain its expected residual income?
A. 2,333 C. 2,667
B. 3,333 D. 3,667 Pol Bobadilla

TRANSFER PRICING
Transfer Pricing Formula
76. The management of James Corporation has decided to implement a transfer pricing
system. James MIS department is currently negotiating a transfer price for its services with
the four producing divisions of the company as well as the marketing department. Charges
will be assessed based on number of reports (assume that all reports require the same
amount of time and resources to produce). The cost to operate the MIS department at its full
capacity of 1,000 reports per year is budgeted at $45,000. The user subunits expect to
request 250 reports each this year. The cost of temporary labor and additional facilities used
to produce reports beyond capacity is budgeted at $48.00 per report. James could purchase
the same services from an external Information Services firm for $70,000. What amounts
should be used as the ceiling and the floor in determining the negotiated transfer price?
 a. b. c. d.
Floor $36.00 $45.60 $48.00 $57.00
Ceiling $56.00 $56.00 $70.00 $82.00

Questions 77 thru 80 are based on the following information. Barfield

Bigole Corp. produces various products used in the construction industry. The Plumbing Division
produces and sells 100,000 copper fittings each month. Relevant information for last month follows:
Total sales (all external) $250,000
Expenses (all on a unit base):
Variable manufacturing $0.50
Fixed manufacturing .25
Variable selling .30
Fixed selling .40
Variable G&A.15
Fixed G&A .50
Total $2.10
Top-level managers are trying to determine how a transfer price can be set on a transfer of 10,000 of
the copper fittings from the Plumbing Division to the Bathroom Products Division.

77. A transfer price based on variable cost will be set at ___________ per unit.
a. $0.50 c. $0.95
b. $0.80 d. $0.75

78. A transfer price based on full production cost would be set at ___________ per unit.
a. $0.75 c. $1.45
b. $2.10 d. $1.60

79. A transfer price based on market price would be set at ___________ per unit.
a. $2.10 c. $1.60
b. $2.50 d. $2.25

80. If the Plumbing Division is operated as an autonomous investment center and its capacity is
100,000 fittings per month, the per-unit transfer price is not likely to be below
a. $0.75. c. $2.10.
b. $1.60. d. $2.50.

Operating at Full Capacity

Minimum Transfer Price
81. The High Division of Para Company produces a high quality kite. Unit production costs
(based on capacity production of 100,000 units per year) follow:
Direct materials P 60
Direct labor 25
Overhead (20% variable) 15
Other information
Sales price 120
Selling expenses (15% variable) 20
The High Division is producing and selling at capacity.
What is the minimum selling price that the division would consider as a transfer price to
the Recreation Division on which no variable period costs would be incurred? (M)
a. P120 c. P 91
b. P 88 d. P117 Pol Bobadilla

82. The Motor Division of Super Truck Co. uses 5,000 carburetors per month in its
production of automotive engines. It presently buys all of the carburetors it needs from two
outside suppliers at an average cost of $100. The Carburetor Division of Super Truck Co.
manufactures the exact type of carburetor that the Motor Division requires. The Carburetor
Division is presently operating at its capacity of 15,000 units per month and sells all of its
output to a foreign car manufacturer at $106 per unit. Its cost structure (on 15,000 units) is:
Variable production costs $70
Variable selling costs 10
All fixed costs 10
Assume that the Carburetor Division would not incur any variable selling costs on units that
are transferred internally. What is the minimum of the transfer price range for a transfer
between the two divisions? (M)
a. $96 c. $70
b. $90 d. $106 Barfield

83. Division A produces a part with the following characteristics:

Capacity in units 50,000
Selling price per unit $30
Variable costs per unit $18
Fixed costs per unit $3
Division B, another division in the company, would like to buy this part from Division A.
Division B is presently purchasing the part from an outside source at $28 per unit. If Division
A sells to Division B, $1 in variable costs can be avoided.
Suppose Division A is currently operating at capacity and can sell all of the units is produces
on the outside market for its usual selling price. From the point of view of Division A, any
sales to Division B should be priced no lower than: (M)
a. $27. c. $20.
b. $29. d. $28. G & N 9e

Maximum Transfer Price

84. The Motor Division of Super Truck Co. uses 5,000 carburetors per month in its
production of automotive engines. It presently buys all of the carburetors it needs from two
outside suppliers at an average cost of $100. The Carburetor Division of Super Truck Co.
manufactures the exact type of carburetor that the Motor Division requires. The Carburetor
Division is presently operating at its capacity of 15,000 units per month and sells all of its
output to a foreign car manufacturer at $106 per unit. Its cost structure (on 15,000 units) is:
Variable production costs $70
Variable selling costs 10
All fixed costs 10
Assume that the Carburetor Division would not incur any variable selling costs on units that
are transferred internally. What is the maximum of the transfer price range for a transfer
between the two divisions? (M)
a. $106 c. $90
b. $100 d. $70 Barfield

Effect on Profit - Make

85. Division A makes a part with the following characteristics:
Production capacity in units 15,000 units
Selling price to outside customers $25
Variable cost per unit $18
Total fixed costs $60,000
Division B, another division of the same company, would like to purchase 5,000 units of the
part each period from Division A. Division B is now purchasing these parts from an outside
supplier at a price of $24 each.
Suppose that Division A is operating at capacity and can sell all of its output to outside
customers at its usual selling price. If Division A sells the parts to Division B at $24 per unit
(Division Bs outside price), the company as a whole will be: (M)
a. better off by $5,000 each period.
b. worse off by $15,000 each period,
c. worse off by $5,000 each period.
d. there will be no change in the status of the company as a whole. G & N 9e

86. The Motor Division of Super Truck Co. uses 5,000 carburetors per month in its
production of automotive engines. It presently buys all of the carburetors it needs from two
outside suppliers at an average cost of $100. The Carburetor Division of Super Truck Co.
manufactures the exact type of carburetor that the Motor Division requires. The Carburetor
Division is presently operating at its capacity of 15,000 units per month and sells all of its
output to a foreign car manufacturer at $106 per unit. Its cost structure (on 15,000 units) is:
Variable production costs $70
Variable selling costs 10
All fixed costs 10
Assume that the Carburetor Division would not incur any variable selling costs on units that
are transferred internally.
If the two divisions agree to transact with one another, corporate profits will (M)
a. drop by $30,000 per month.
b. rise by $20,000 per month.
c. rise by $50,000 per month.
d. rise or fall by an amount that depends on the level of the transfer price. Barfield

Comprehensive
Questions 87 and 88 are based on the following information. RPCPA 0585
Rosas Corporation has several operating divisions. Three divisions are treated as profit
centers and its division managers are free to choose their sources of sale and supply. One of
its divisions, Gumamela Division, manufactures steel containers, 20% of which are sold to
Daisy Division and the balance to outside customers. Inter-divisional sales and purchases are
recorded at variable cost as a transfer price. Based on a full capacity of 150,000 units, the
estimated sales and standard cost data for Gumamela Division for the year 1985 are as
follows:

Daisy Outsiders
Sales P 900,000 P 9,600,000
Variable costs (900,000) (3,600,000)
Fixed costs (200,000) (800,000)
Gross margin P(200,000) P 5,200,000
Unit sales 30,000 120,000
Gumamela has the option to sell the above 30,000 units to an outside customer at a price of
P50 per unit during 1985 on a continuing basis. Daisy in turn may purchase its requirements
from an outside supplier at a price of P60 per unit.
87. Assuming that Gumamela wishes to improve its gross margin, should Gumamela
accept the order of the new customer, and drop its sales to Daisy for 1985 and why? (M)
a. No, because the gross margin from the companys overall viewpoint would decrease
by P300,000.
b. Yes, because Gumamela Divisions gross margin would increase by P300,000.
c. Yes, because Gumamela Divisions gross margin would increase by P600,000.
d. No, because Daisy Divisions gross margin would decrease by P900,000.

88. Assume, however, that Rosa Corporation allows the division managers to negotiate
the transfer price for 1985. The managers agreed on a tentative transfer price of P50 per
unit; to be reduced based on an equal sharing of the additional gross margin to Gumamela
resulting from the sales to Daisy of 30,000 units at P50 per unit. The actual transfer price for
1985 would be (M)
a. P35.50 c. P45.00
b. P40.00 d. P50.00

Questions 89 thru 91 are based on the following information. CMA 0696 3-26 to 28
Parkside, Inc. has several divisions that operate as decentralized profit centers. Parksides
Entertainment Division manufactures video arcade equipment using the products of two of
Parksides other divisions. The Plastics Division manufactures plastic components, one type
that is made exclusively for the Entertainment Division, while other less complex components
are sold to outside markets. The products of the Video Cards Division are sold in a
competitive market, however, one video card model is also used by the Entertainment
Division. The actual costs per unit used by the Entertainment Division are presented below.

Plastic Components Video Cards

Direct material $ 1.25 $ 2.40
Direct labor 2.35 3.00
Variable overhead 1.00 1.50
Fixed overhead 0.40 2.25
Total cost $ 5.00 $ 9.15

The Plastics Division sells its commercial products at full cost plus a 25% markup and believes
the proprietary plastic component made for the Entertainment Division would sell for $6.25
per unit on the open market. The market price of the video card used by the Entertainment
Division is $10.98 per unit.

89. A per-unit transfer price from the Video Cards Division to the Entertainment Division
at full cost, $9.15, would (M)
a. Allow evaluation of both divisions on a competitive basis.
b. Satisfy the Video Cards Divisions profit desire by allowing recovery of opportunity
costs.
c. Provide no profit incentive for the Video Cards Division to control or reduce costs.
d. Encourage the Entertainment Division to purchase video cards from an outside source.

90. Assume that the Entertainment Division is able to purchase a large quantity of video
cards from an outside source at $8.70 per unit. The Video Cards Division having excess
capacity, agrees to lower its transfer price to $8.70 per unit. This action would (M)
a. Optimize the profit goals of the Entertainment Division while subverting the profit
goals of Parkside, Inc.
b. Allow evaluation of both divisions on the same basis.
c. Subvert the profit goals of the Video Cards Division while optimizing the profit goals of
the Entertainment Division.
d. Optimize the overall profit goals of Parkside, Inc.

91. Assume that the Plastic Division has excess capacity and it has negotiated a transfer
price of $5.60 per plastic component with the Entertainment Division. This price will (M)
a. Cause the Plastics Division to reduce the number of commercial plastic components it
manufactures.
b. Motivate both divisions as estimated profits are shared.
c. Encourage the Entertainment Division to seek an outside source for plastic
components.
d. Demotivate the Plastics Division causing mediocre performance.

Operating with Partial Excess Capacity

Minimum Transfer Price
92. Division X of Charter Corporation makes and sells a single product which is used by
manufacturers of fork lift trucks. Presently it sells 12,000 units per year to outside customers
at $24 per unit. The annual capacity is 20,000 units and the variable cost to make each unit is
$16. Division Y of Charter Corporation would like to buy 10,000 units a year from Division X
to use in its products. There would be no cost savings from transferring the units within the
company rather than selling them on the outside market. What should be the lowest
acceptable transfer price from the perspective of Division X? (D)
a. $24.00 c. $17.60
b. $21.40 d. $16.00 G & N 9e

93. The Post Division of the M.T. Woodhead Company produces basic posts which can be
sold to outside customers or sold to the Lamp Division of the M.T. Woodhead Company. Last
Year the Lamp Division bought all of its 25,000 posts from Post at $1.50 each. The following
data are available for last year's activities of the Post Division:
Capacity in units 300,000 posts
Selling price per post to outside customers $1.75
Variable costs per post $0.90
Fixed costs, total $150,000
Suppose the transfers of posts to the Lamp Division cut into sales to outside customers by
15,000 units. What is the lowest transfer price that would not reduce the profits of the Post
Division? (D)
a. $0.90. c. $1.41.
b. $1.35. d. $1.75. G & N 9e

94. The Vega Division of Ace Company makes wheels which can either be sold to outside
customers or transferred to the Walsh Division of Ace Company. Last month the Walsh
Division bought all 4,000 of its wheels from the Vega Division for $42 each. The following data
are available from last month's operations for the Vega Company:
Capacity 12,000 wheels
Selling price per wheel to outside customers $45
Variable costs per wheel when sold to outside customers $30
If the Vega Division sells wheels to the Walsh Division, Vega can avoid $2 per wheel in sales
commissions. An outside supplier has offered to supply wheels to the Walsh Division for $41
each.
Suppose that Vega can sell 9,000 wheels each month to outside consumers, so transfers to
the Walsh Division cut into outside sales. What should be the lowest acceptable transfer price
from the perspective of the Vega Division? (VD)
a. $28.00 c. $41.00
b. $31.75 d. $42.00 G & N 9e

Effect on Profit - Make

95. Division P of Turbo Corporation has the capacity for making 75,000 wheel sets per
year and regularly sells 60,000 each year on the outside market. The regular sales price is
$100 per wheel set, and the variable production cost per unit is $65. Division Q of Turbo
Corporation currently buys 20,000 wheel sets (of the kind made by Division P) yearly from an
outside supplier at a price of $90 per wheel set. If Division Q were to buy the 20,000 wheel
sets it needs annually from Division P at $87 per wheel set, the change in annual net
operating income for the company as a whole, compared to what it is currently, would be: (D)
a. $225,000. c. $500,000.
b. $325,000 d. $75,000. G & N adapted

Effect on Profit - Buy

96. The Post Division of the M.T. Woodhead Company produces basic posts which can be
sold to outside customers or sold to the Lamp Division of the M.T. Woodhead Company. Last
Year the Lamp Division bought all of its 25,000 posts from Post at $1.50 each. The following
data are available for last year's activities of the Post Division:
Capacity in units 300,000 posts
Selling price per post to outside customers $1.75
Variable costs per post $0.90
Fixed costs, total $150,000
Suppose the transfers of posts to the Lamp Division cut into sales to outside customers by
15,000 units. Further suppose that an outside supplier is willing to provide the Lamp Division
with basic posts at $1.45 each. If the Lamp Division had chosen to buy all of its posts from the
outside supplier instead of the Post Division, the change in net operating income for the
company as a whole would have been: (D)
a. $1,250 decrease. c. $1,000 decrease.
b. $10,250 increase. d. $13,750 decrease. G & N 9e

Operating at Idle Capacity

Minimum Transfer Price
97. Division A makes a part that it sells to customers outside of the company. Data
concerning this part appear below:
Selling price to outside customers $40
Variable cost per unit $30
Total fixed costs $10,000
Capacity in units 20,000
Division B of the same company would like to use the part manufactured by Division A in one
of its products. Division B currently purchases a similar part made by an outside company for
$38 per unit and would substitute the part made by Division A. Division B requires 5,000 units
of the part each period. Division A has ample capacity to produce the units for Division B
without any increase in fixed costs and without cutting into sales to outside customers. If
Division A sells to Division B rather than to outside customers, the variable cost be unit would
be $1 lower. What should be the lowest acceptable transfer price from the perspective of
Division A? (M)
a. $40. c. $30.
b. $38. d. $29. G & N 9e

98. Division A produces a part with the following characteristics:

Capacity in units 50,000
Selling price per unit $30
Variable costs per unit $18
Fixed costs per unit $3
Division B, another division in the company, would like to buy this part from Division A.
Division B is presently purchasing the part from an outside source at $28 per unit. If Division
A sells to Division B, $1 in variable costs can be avoided.
Suppose that Division A has ample idle capacity to handle all of Division B's needs without
any increase in fixed costs and without cutting into its sales to outside customers. From the
point of view of Division A, any sales to Division B should be priced no lower than: (M)
a. $29. c. $18.
b. $30. d. $17. G & N 9e
Maximum Transfer Price
99. Cline Company had the following historical accounting data per unit:
Direct materials $20
Direct labor 10
Variable manufacturing overhead 5
Fixed manufacturing overhead 8
Variable selling expenses 15
Fixed selling expenses 3
The units are normally transferred internally from Division X to Division Y. The units also may
be sold externally for $70 per unit. The minimum profit level accepted by the company is a
markup of 30 percent. There were no beginning or ending inventories.

If the negotiated price is used, Division Xs transfer price should be

a. a maximum of $70.00 d. a minimum of $40.00
b. a minimum of $51.00 e. a minimum of $43.00.
c. a maximum of $66.30 H&M

Minimum & Maximum Transfer Price

Questions 100 & 101 are based on the following information. G & N 9e
The Vega Division of Ace Company makes wheels which can either be sold to outside
customers or transferred to the Walsh Division of Ace Company. Last month the Walsh
Division bought all 4,000 of its wheels from the Vega Division for $42 each. The following data
are available from last month's operations for the Vega Company:

Capacity 12,000 wheels

Selling price per wheel to outside customers $45
Variable costs per wheel when sold to outside customers $30
If the Vega Division sells wheels to the Walsh Division, Vega can avoid $2 per wheel in sales
commissions. An outside supplier has offered to supply wheels to the Walsh Division for $41
each.

100. Suppose that the Vega Division has ample idle capacity so that transfers to the Walsh
Division would not cut into its sales to outside customers. What should be the lowest
acceptable transfer price from the perspective of the Vega Division? (M)
a. $28 c. $42
b. $30 d. $45

101. What is the maximum price per wheel that Walsh should be willing to pay Vega? (M)
a. $28 c. $42
b. $41 d. $45 G & N 9e

Optimal Transfer Price

102. Division Z of a company produces a component that it currently sells to outside
customers for $20 per unit. At its current level of production, which is 60% of capacity,
Division Z's fixed cost of producing this component is $5 per unit and its variable cost is $12
per unit. Division Y of the same company would like to purchase this component from
Division Z for $10. Division Z has enough excess capacity to fill Division Y's requirements. The
managers of both divisions are compensated based upon reported profits. Which of the
following transfer prices will maximize total company profits and be most equitable to the
managers of Division Y and Division Z? (M)
A. $12 per unit. C. $20 per unit.
B. $18 per unit. D. $22 per unit. CIA 0592 IV-19

103. Nita Corps Department 1 produced component C that is used by OZM as a key part.
Production and sales data for component C is as follows:

Selling price per unit P100

Variable cost per unit 36
Fixed cost per unit (based on 10,000 annual capacity) 24

Nita Corp.s Department II is introducing a new product that will use component C. An
outside supplier has quoted Department II a price of P96 per unit. This represents the usual
P100 price less a quantity discount due to the large number of Department IIs requirements.
The Company has transfer price formula of: Transfer price = Variable cost per unit + Lost
contribution margin per unit on outside sales.
Department I has enough excess capacity to handle all of Department IIs needs. For the
overall interest of the company, Department I should (M)
a. Sell to Department II at the same quoted price of P96 per unit.
b. Sell to Department II at minimum price of P60 per unit.
c. Not sell to Department II since it will lose P4 per unit.
d. Sell to Department II at P100 per unit. RPCPA 1096

104. A company has two divisions, A and B, each operated as a profit center. A charges B
$35 per unit for each unit transferred to B. Other data follows:

As variable cost per unit $30

As fixed costs 10,000
As annual sales to B 5,000 units
As sales to outsiders 50,000 units

A is planning to raise its transfer price to $50 per unit, Division B can purchase units at $40
each from outsiders, but doing so would idle As facilities now committed to producing units
for B. Division A cannot increase its sales to outsiders. From the perspective of the company
as a whole, from whom should Division B acquire the units, assuming Bs market is
unaffected? (M)
a. Outside vendors.
b. Division A, but only at the variable cost per unit.
c. Division A, but only until fixed costs are covered, then from outside vendors.
d. Division A, despite the increased transfer price. CIA 1183 IV-5

Effect on Profit
Questions 105 & 106 are based on the following information. L & H 10e
Alcatraz Division of XYZ Corp. sells 80,000 units of part X to the outside market. Part X sells
for $40, has a variable cost of $22, and a fixed cost per unit of $10. Alcatraz has a capacity to
produce 100,000 units per period. Capone Division currently purchases 10,000 units of part X
from Alcatraz for $40. Capone has been approached by an outside supplier willing to supply
the parts for $36.

105. What is the effect on XYZ's overall profit if Alcatraz REFUSES the outside price and
Capone decides to buy outside? (M)
a. no change c. $80,000 decrease in XYZ profits
b. $140,000 decrease in XYZ profits d. $40,000 increase in XYZ profits
106. What is the effect on XYZ's overall profit if Alcatraz ACCEPTS the outside price and
Capone continues to buy inside? (M)
a. no change c. $80,000 decrease in XYZ profits
b. $140,000 decrease in XYZ profits d. $40,000 increase in XYZ profits

107. Division A makes a part with the following characteristics:

Production capacity in units 15,000 units

Selling price to outside customers $25
Variable cost per unit $18
Total fixed costs $60,000

Division B, another division of the same company, would like to purchase 5,000 units of the
part each period from Division A. Division B is now purchasing these parts from an outside
supplier at a price of $24 each.

Suppose that Division A has ample idle capacity to handle all of Division B's needs without
any increase in fixed costs and without cutting into sales to outside customers. If Division B
continues to purchase parts from an outside supplier rather then from Division A, the
company as a whole will be: (M) G & N 9e
a. worse off by $30,000 each period. c. better off by $15,000 each period.
b. worse off by $10,000 each period. d. worse off by $35,000 each period.

International Transfer Pricing

108. Hancock Manufacturing has one plant located in Italy and another plant located in the
U.S. The Italian plant manufactures a component used in a finished product manufactured at
the U.S. plant. Currently, the Italian plant is operating at 75 percent capacity. In Italy the
income tax rate is 32 percent; in the U.S. the corporate income tax rate is 35 percent.

The market price of the component is $120 and the Italian plants costs to manufacture the
component are as follows:

Direct materials $30

Direct labor 20
Variable overhead 10
Fixed overhead 15
Which transfer price would be in the best interest of the overall corporation?
a. $60 c. $75
b. $50 d. $120 H & M

109. Pacific Company has three plants: one located in Malaysia, one in India and another
plant located in the Philippines. Both plants manufactures a component used in a finished
product manufactured in the Philippine plant. Currently, both plants are operating at 70%
capacity. In Malaysia the income tax rate is 42% while in India the tax rate is 35%; in the
Philippines, the corporate income tax rate is 40%.

The market price of the component, in peso equivalent, is P100 and the foreign plants costs
to manufacture the component are as follows:

Direct materials P10

Direct labor 20
Variable overhead 5
Fixed overhead 25

Which transfer price would be in the best interest of the overall corporation?

Pol Bobadilla A. B. C. D.
Malaysia P35 P 35 P100 P100
India P35 P100 P100 P 35

Questions 110 thru 112 are based on the following information. H & M
Hanover Manufacturing has one plant located in Belgium and another plant located in the
U.S. The Belgium plant manufactures a component used in a finished product manufactured
at the U.S. plant. Currently, the Belgium plant is operating at 70 percent capacity. In Belgium
the income tax rate is 42 percent; in the U.S. the corporate income tax rate is 35 percent.

The market price of the component is $100 and the Belgium plants costs to manufacture the
component are as follows:

Direct materials $10

Direct labor 20
Variable overhead 5
Fixed overhead 25

110. What is the minimum transfer price that the Belgium division would be willing to
accept?
a. $35 c. $60
b. $55 d. $100

111. What is the maximum transfer price that the U.S. division would be willing to pay?
a. $35 c. $60
b. $55 d. $100

112. Which transfer price would be in the best interest of the overall corporation?
a. $35 c. $60
b. $55 d. $100

Questions 113 thru 115 are based on the following information. H & M
Hampton Manufacturing has one plant located in Belgium and another plant located in the
U.S. The Belgium plant manufactures a component used in a finished product manufactured
at the U.S. plant. Currently, the Belgium plant is operating at 70 percent capacity. In Belgium
the income tax rate is 30 percent; in the U.S. the corporate income tax rate is 35 percent.

The market price of the component is $140 and the Belgium plants costs to manufacture the
component are as follows:

Direct materials $15

Direct labor 25
Variable overhead 6
Fixed overhead 28

113. What is the minimum transfer price that the Belgium division would be willing to
accept?
a. $140 c. $68
b. $74 d. $46

114. What is the maximum transfer price that the U.S. division would be willing to pay?
a. $140 c. $68
b. $74 d. $46

115. Which transfer price would be in the best interest of the overall corporation?
a. $140 c. $68
b. $74 d. $46
Comprehensive
Questions 116 through 118 are based on the following information. CMA 1290 3-21 to 23
Adler Industries is a vertically integrated firm with several divisions that operate as
decentralized profit centers. Adler's Systems Division manufactures scientific instruments and
uses the products of two of Adler's other divisions. The Board Division manufactures printed
circuit boards (PCBs). One PCB model is made exclusively for the Systems Division using
proprietary designs, whereas less complex models are sold in outside markets. The products
of the Transistor Division are sold in a well-developed competitive market; however, one
transistor model is also used by the Systems Division.

The costs per unit of the products used by the Systems Division are as follows:

PCB Transistor
Direct materials $2.50 $ .80
Direct labor 4.50 1.00
Variable overhead 2.00 .50
Fixed overhead .80 .75
Total cost $9.80 $3.05

The Board Division sells its commercial products at full cost plus a 25% markup and believes
the proprietary board made for the Systems Division would sell for $12.25 per unit on the
open market. The market price of the transistor used by the Systems Division is $3.70 per
unit.

116. A per unit transfer price from the Transistor Division to the Systems Division at full
cost, $3.05, would
A. Allow evaluation of both divisions on a competitive basis.
B. Satisfy the Transistor Division's profit desire by allowing recovery of opportunity costs.
C. Demotivate the Systems Division and cause mediocre performance.
D. Provide no profit incentive for the Transistor Division to control or reduce costs.

117. Assume the Systems Division is able to purchase a large quantity of transistors from
an outside source at $2.90 per unit. The Transistor Division, having excess capacity, agrees to
lower its transfer price to $2.90 per unit. This action would
A. Optimize the profit goals of the Systems Division while subverting the profit goals of
Adler Industries.
B. Allow evaluation of both divisions on the same basis.
C. Subvert the profit goals of the Transistor Division while optimizing the profit goals of
the Systems Division.
D. Optimize the overall profit goals of Adler Industries.
118. The Board and Systems Divisions have negotiated a transfer price of $11.00 per
printed circuit board. This price will
A. Cause the Board Division to reduce the number of commercial printed circuit boards it
manufactures.
B. Motivate both divisions as estimated profits are shared.
C. Encourage the Systems Division to seek an outside source for printed circuit boards.
D. Demotivate the Board Division causing mediocre performance.

Questions 119 through 123 are based on the following information. Barfield
Office Products Inc. manufactures and sells various high-tech office automation products.
Two divisions of Office Products Inc. are the Computer Chip Division and the Computer
Division. The Computer Chip Division manufactures one product, a "super chip," that can be
used by both the Computer Division and other external customers. The following information
is available on this month's operations in the Computer Chip Division:

Selling price per chip $50

Variable costs per chip $20
Fixed production costs $60,000
Fixed SG&A costs $90,000
Monthly capacity 10,000 chips
External sales 6,000 chips
Internal sales 0 chips

Presently, the Computer Division purchases no chips from the Computer Chips Division, but
instead pays $45 to an external supplier for the 4,000 chips it needs each month.

119. Assume that next month's costs and levels of operations in the Computer and
Computer Chip Divisions are similar to this month. What is the minimum of the transfer price
range for a possible transfer of the super chip from one division to the other?
a. $50 c. $20
b. $45 d. $35

120. Assume that next month's costs and levels of operations in the Computer and
Computer Chip Divisions are similar to this month. What is the maximum of the transfer price
range for a possible transfer of the chip from one division to the other?
a. $50 c. $35
b. $45 d. $30

121. Two possible transfer prices (for 4,000 units) are under consideration by the two
divisions: $35 and $40. Corporate profits would be _______ if $35 is selected as the transfer
price rather than $40.
a. $20,000 larger c. $20,000 smaller
b. $40,000 larger d. the same

122. If a transfer between the two divisions is arranged next period at a price (on 4,000
units of super chips) of $40, total profits in the Computer Chip division will
a. rise by $20,000 compared to the prior period.
b. drop by $40,000 compared to the prior period.
c. drop by $20,000 compared to the prior period.
d. rise by $80,000 compared to the prior period.

123. Assume, for this question only, that the Computer Chip Division is selling all that it can
produce to external buyers for $50 per unit. How would overall corporate profits be affected
if it sells 4,000 units to the Computer Division at $45? (Assume that the Computer Division
can purchase the super chip from an outside supplier for $45.)
a. no effect c. $20,000 decrease
b. $20,000 increase d. $90,000 increase

Questions 124 thru 126 are based on the following information. Barfield
The Motor Division of Super Truck Co. uses 5,000 carburetors per month in its production of
automotive engines. It presently buys all of the carburetors it needs from two outside
suppliers at an average cost of $100. The Carburetor Division of Super Truck Co. manufactures
the exact type of carburetor that the Motor Division requires. The Carburetor Division is
presently operating at its capacity of 15,000 units per month and sells all of its output to a
foreign car manufacturer at $106 per unit. Its cost structure (on 15,000 units) is:

Variable production costs $70

Variable selling costs 10
All fixed costs 10

Assume that the Carburetor Division would not incur any variable selling costs on units that
are transferred internally.
124. What is the maximum of the transfer price range for a transfer between the two
divisions?
a. $106 c. $90
b. $100 d. $70
125. What is the minimum of the transfer price range for a transfer between the two
divisions?
a. $96 c. $70
b. $90 d. $106

126. If the two divisions agree to transact with one another, corporate profits will
a. drop by $30,000 per month.
b. rise by $20,000 per month.
c. rise by $50,000 per month.
d. rise or fall by an amount that depends on the level of the transfer price.

Questions 127 through 133 are based on the following information. Gleim
The information was presented as part of Question 6 on Part 4 of the December 1981 CMA
Examination.
PortCo Products is a divisionalized furniture manufacturer. The divisions are autonomous
segments, with each division being responsible for its own sales, costs of operations, working
capital management, and equipment acquisition. Each division serves a different market in
the furniture industry. Because the markets and products of the divisions are so different,
there have never been any transfers between divisions.

The Commercial Division manufactures equipment and furniture that are purchased by the
restaurant industry. The division plans to introduce a new line of counter and chair units that
feature a cushioned seat for the counter chairs. John Kline, the division manager, has
discussed the manufacturing of the cushioned seat with Russ Flegel for a price for 100-unit
lots of the cushioned seat. The following conversation took place about the price to be
charged for the cushioned seats:

Flegel: John, we can make the necessary modifications to the cushioned seat easily. The
raw materials used in your seat are slightly different and should cost about 10% more than
those used in our deluxe office stool. However, the labor time should be the same because
the seat fabrication operation basically is the same. I would price the seat at our regular rate
full cost plus 30% markup.
Kline: This is higher than I expected. Russ, I was thinking that a good price would be your
variable manufacturing costs. After all, your capacity costs will be incurred regardless of the
job.
Flegel: John, Im at capacity. By making the cushion seats for you, Ill have to cut my
production of deluxe office stools. Of course, I can increase my production of economy office
stools. The labor time freed by not having to fabricate the frame or assemble the deluxe
stool can be shifted to the frame fabrication and assembly of the economy office stool.
Fortunately, I can switch my labor force between these two models of stools without any loss
of efficiency. As you know, overtime is not a feasible alternative in our community. Id like
to sell it to you at variable cost, but I have excess demand for both products. I dont mind
changing my product mix to the economy model if I get a good return on the seats I make for
you. Here are my standard costs for the two stools and a schedule of my manufacturing
overhead.

Kline: I guess I see your point, Russ, but I dont want to price myself out of the market.
Maybe we should talk to Corporate to see if they can give us any guidance.

Office Division
Standard Costs and Prices

Deluxe Office Stool Economy Office Stool

Raw materials
Framing $ 8.15 $ 9.76
Cushioned seat
Padding 2.40 -
Vinyl 4.00 -
Molded seat (purchased) 6.00
Direct labor
Frame fabrication (.5x$7.50/DLH) 3.75 (.5x$7.50/DLH) 3.75
Cushion fabrication (.5x$7.50/DLH) 3.75 -
Assembly* (.5x$7.50/DLH) 3.75 (.3x$7.50/DLH) 2.25
Manufacturing
Overhead (1.5DLHx$12.60/DLH) 19.20 (.8DLHx$12.80/DLH) 10.24
Total standard cost $45.00 $32.00
Selling price (30% markup) $58.50 $41.60
* Attaching seats to frames and attaching rubber feet.

Office Division
Manufacturing Overhead Budget

Overhead Item Nature Amount

Supplies Variable at current market prices $ 420,000
Indirect labor Variable 375,000
Supervision Nonvariable 250,000
Power Use varies with activity; rates are fixed 180,000
Heat and light Nonvariable light is fixed regardless of production while heat/airconditioning
varies with fuel charges 140,000
Property taxes and insurance taxes Nonvariable any change in amounts/rates is
independent of production 200,000
Depreciation Fixed dollar total 1,700,000
Employee benefits 20% of supervision, direct and indirect labor 575,000
Total overhead $3,840,000
Capacity in DLH 300,000
Overhead rate/DLH $12.80
127. What amount of employee benefit is associated with direct labor costs? (E)
a. $675,000 c. $450,000
b. $75,000 d. $500,000

128. What is the variable manufacturing overhead rate? (E)

a. $7.80/hr. c. $5.17/hr.
b. $11.25/hr. d. $5.00/hr.

129. What is the transfer price per 100-unit lot based on variable manufacturing costs to
produce the modified cushioned seat? (E)
a. $1,329 c. $789
b. $1,869 d. $1,986

130. What is the fixed manufacturing overhead rate? (E)

a. $7.80/hr. c. $5.17/hr.
b. $11.25/hr. d. $5.00/hr.

131. How many economy office stools can be produced with the labor hours currently used
to make 100 deluxe stools? (E)
a. 187 c. 100
b. 125 d. 150
132. When computing the opportunity cost for the deluxe office stool, what is the
contribution margin per unit produced? (E)
a. $25.20 c. $45.00
b. $15.84 d. $33.30

133. What is the opportunity cost of the Office Division if 125 economy stools can be made
in the time required for 100 deluxe stools? (E)
a. $789 c. $1,329
b. $1,869 d. $540
Answer Key

1. A 11. D 21. D 31. A 41. A

2. B 12. C 22. C 32. A 42. B
3. B 13. D 23. B 33. B 43. C
4. B 14. C 24. B 34. B 44. A
5. A 15. C 25. A 35. D 45. C
6. B 16. D 26. C 36. A 46. A
7. C 17. B 27. D 37. C 47. B
8. B 18. D 28. B 38. C 48. C
9. B 19. B 29. D 39. C 49. D
10. A 20. B 30. B 40. B 50. A

51. B 61. A 71. C 81. D 91. B

52. B 62. E 72. A 82. A 92. C
53. E 63. B 73. C 83. B 93. C
54. A 64. D 74. B 84. B 94. B
55. C 65. B 75. A 85. C 95. B
56. C 66. D 76. B 86. B 96. C
57. B 67. A 77. C 87. C 97. D
58. D 68. C 78. A 88. B 98. D
59. E 69. C 79. B 89. C 99. A
60. C 70. D 80. D 90. D 100. A

101. B 111. D 121. D 131. B

102. B 112. A 122. D 132. A
103. A 113. D 123. C 133. D
104. D 114. A 124. B
105. B 115. A 125. A
106. A 116. D 126. C
107. A 117. D 127. C
108. D 118. B 128. D
109. B 119. C 129. A
110. A 120. B 130. A