Question

Week 10 (Topic 9)

a. Fragrance Pty Ltd has two (2) divisions: the Cologne Division and the Bottle Division. The company is de-centralised and each division is evaluated as a profit centre.

The Bottle Division produces bottles that can be used by the Cologne Division. The Bottle Division's variable manufacturing cost per unit is $2.00 and shipping costs are $0.10 per unit. The Bottle Division's external sales price is $3.00 per unit. No shipping costs are incurred on sales to the Cologne Division. The Cologne Division can purchase similar bottles in the external market for $2.50. The Bottle Division has sufficient capacity to meet all external market demands in addition to meeting the demands of the Cologne Division.

Using the general rule, calculate the minimum transfer price from the Bottle Division to the Cologne Division. Explain your answer

b. For the period just ended, Trek Corporation's Trailer Division reported profit of $54 million and invested capital of $450 million. Assuming an imputed interest rate of 10 per cent, calculate Trailer’s return on investment (ROI) and residual income. Explain what each calculation of ROI and RI means for Trek. ( 6 marks)

Answer 1

Part a
	The minimum transfer price which will be quoted by Bottle division will be equal to the variable manufacturing cost per unit
	Minimum Transfer Price to be quoted by Bottle division =$2.00 per unit
	Since the Bottle division will not incurr the Shipping cost when transferred to Cologne division hence the Shipping cost will
	not be included in the Minimum transfer price quoted to Cologne division. Also, the contribution margin foregone will not be considered
	as the Bottle division has sufficient capacity.
Part b	Calculation of ROI
	Net Operating Income	$54 million
	Average Invested Assets	$450 million
	ROI =Net Operating Income / Average Total Assets	12%
	Residual income of last year =Net operating income -(Average Invested assets*10%)	$9 million
	Return on Investment means that the on the invested capital the division is earning a return of 12%
	Residual Income of $9 million means that it is earning that much amount more than the required return of 10%