Question

aroque Beverages (BB) produces and sells fruit drinks. Production is done in two stages: (1) fresh fruit is processed into juice concentrate and (2) juice concentrate is processed into the final beverage. Currently, BB has one factory that can process 7,500 units of juice concentrate and 10,000 units of the final beverage (one unit of juice concentrate is required to make one unit of the final beverage). Expected per unit manufacturing costs, based on production of 7,500 units, in the two stages are as follows:

​Stage One​Stage Two

​Direct Material​ £80​ £90

​Direct Labor​ £40​ £20

​Variable OH​ £60​ £30

​Fixed OH​ £50​ £30

For the upcoming fiscal year, Ferenc Deák (the divisional manager of BB) expects demand to be for 10,000 units of the final beverage at a price of £750/unit; however he is constrained to selling only 7,500 units (and therefore only expects to produce 7,500 units of both the juice concentrate and the final beverage). Additionally, he expects to incur £1,175,000 in fixed non-manufacturing costs and £750,000 in corporate overhead charges. This charge is meant to ensure that Ferenc's division pays for its usage of corporate services (including general marketing, legal and R&D). When Ferenc enquired as to the rationale for the amount of the allocation, he was told that it was because his division was one of the largest divisions of the company.

Ferenc is paid a bonus of 3% of BB residual income (but before bonus payment) and 1% of the corporate residual income (but before bonus payments); corporate profit is forecasted to be £1,890,000. The capital invested in BB is equal to £3,000,000 and the capital invested in the company as a whole is equal to £12,000,000. The corporate wide cost of capital is 10%.

Required:

a. Calculate Ferenc's expected bonus for the next fiscal year.

Ferenc has been approached by Irina Spalko - manager of Mamadou (another division within the same company) - who wants to supply BB with 10,000 units of juice concentrate (in an all-or-nothing transaction). Ferenc knows that the decentralized structure of the organisation means that he can decide whether to accept the offer, without interference from the head office. Ferenc also knows that if he accepts the offer, then the factory space dedicated to producing juice concentrate will sit idle.

b. Calculate the maximum transfer price that Ferenc would be willing to pay per unit to Mamadou for 10,000 units of juice concentrate to ensure that BB profit remains unchanged. (Note: the budgeted corporate charge will remain at £750,000).

Answer 1

capacity	7500 units
Sales	7500 units
sales price/unit	750
Total Sales	5625000	i.e. 7500*750
Cost of production	concentrate	final beverage
No of units	7500	7500	a
DIRECT MATERIAL	80	90
DIRECT LABOUR	40	20
VARIABLE OH	60	30
FIXED OH	50	30
Total cost /unit	230	170	b
Total cost of 7500 units	1725000	1275000	i.e. a*b
calculation of residual Income
Total Sales		5625000
Less total cost of
concentrate	1725000
final beverage	1275000	3000000
		2625000
Less:fixed non manufacturing costs	1175000
Less:Corporate overhead chgs	750000	1925000
BB Net Profit		700000
BB Net Profit		300000
amount invested in BB * 10% i.e. 3000000*.1
residual Income BB		400000
calculation of residual income corporate
corporate profit	1890000
less: cost of capital	1200000
12000000*.1
residual income	690000
assumption
corporate profit includes bb profit and excludes bonus
Answer   a
Bonus calculation
3 % of BB residual income i.e. 400000*.03		12000
1 % of corporate residual income i.e. 690000*.01		6900
Expected Bonus next fiscal year		18900
Answer   b
Reverse working done from profit to cost of concentrate
BB net profit		700000
Add: fixed Non manufacturing cost	1175000
Add: corporate overhead chgs	750000	1925000
		2625000
Add: Total cost of final beverages 10000unit		1700000
b(above calculation) * 10000 i.e. 170*10000
		4325000
sales 10000*750		7500000
maximum cost can be incurred on 10000 units of concentrate		-3175000
cost per unit for concentrate i.e. 3175000/10000		317.5
maximum transfer price that Ferenc would be willing to pay per unit to Mamadou for 10,000 units of juice concentrate to ensure that BB profit remains unchanged		317.5