Question

York Candy Company makes two kinds of candy: mint and caramels. It operates each product line as a division: Mint Division and Caramel Division. Each division is treated as an investment center, and the division managers are responsible for making the investment decisions in their own divisions. Information about the two divisions is summarized below.

	Mint Division	Caramel Division	Total
Revenue	$2,000,000	$1,250,000	$3,250,000
Variable Costs	1,300,000	950,000	2,250,000
Fixed Costs	650,000	265,000	915,000
Operating Income	50,000	35,000	85,000
Average Operating Assets	$550,000	$250,000	$800,000
Current Liabilities	$80,000	$50,000	$130,000
Return on Investment(ROI)	9.09%	14%	11%
Contribution Margin Ratio	35%	24%	30.77%

The target rate of return for both divisions is 11%.

Required:

1. Compute the residual income for the Mint Division.
2. Assume that divisions are evaluated on the basis on ROI. Mint Division has the opportunity to make an investment that will yield 10%. Will the Mint Division manager want to make this investment? Explain. Would York's central management want Mint Division to make this investment? Explain.
3. The Mint Division manager believes she can increase sales volume without investing in the new asset. By what amount would revenue need to increase in order to generate an ROI of 15%?
4. York believes that caramels are becoming more popular. As a result, the Caramel Division's sales volume is expected to grow, and the Mint Division's sales volume is expected to remain steady. York anticipates that Caramel Division will represent 55% of next year's sales volume. Compute York's anticipated contribution margin ratio.

Answer 1

(1) Compute the residual income for the Mint Division.

=Actual Income-Required return

=Actual income -operating asset*minimum required rate of return

=$50,000 -($550,000*11%]

=$50,000-60,500

= -$10,500

(2) Assume that divisions are evaluated on the basis on ROI. Mint Division has the opportunity to make an investment that will yield 10%. Will the Mint Division manager want to make this investment? Explain. Would York's central management want Mint Division to make this investment? Explain.

Mint division manager would want to make this investment because yeild 10% is higher than mint divisions' ROI of 9.09%. So, its manager would be interested as it will increase division ROI.YES

No, York's central management would not want to make this investment as its required return is 11%. Investment yeilding 10% would reduce its Overall ROI. so it will reject this prosposal.

(3) The Mint Division manager believes she can increase sales volume without investing in the new asset. By what amount would revenue need to increase in order to generate an ROI of 15%?

• ROI required = $550,000*15%

                               =$82,500

• contribution margin = revenue-variable cost

                                           =$2,000,000-1,300,000

                                          =$700,000

• Revenue*CM ratio - fixed cost = profit required

           Revenue*35%-$650,000 =$82,500

            Revenue =$2,092,857

• Increase in revenue = $2,092,857-$2,000,000

                                           =$92,857

(4) York believes that caramels are becoming more popular. As a result, the Caramel Division's sales volume is expected to grow, and the Mint Division's sales volume is expected to remain steady. York anticipates that Caramel Division will represent 55% of next year's sales volume. Compute York's anticipated contribution margin ratio.

	Mint	Caramel	Total
CM ratio [sales-variable cost]/sales	0.35	0.24[$1,250,000-$950,000]/1,250,000
sales mix	0.45	0.55	1
weighted CM ratio	0.1575	0.132	0.2895

Contribution margin ratio = [0.35*0.45]+[0.24+0.55]

=28.95%

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