Question

In: Accounting

Division A of a firm produces a single product, which is sold only to Division B....

Division A of a firm produces a single product, which is sold only to Division B. Division A has a total investment of $1,000,000, while Division B has a total investment of $2,000,000. Division A annually sells 100,000 units of its product to Division B for $5 per unit and earns $150,000 in operating profit. Division B currently earns $250,000. If Division A raises its selling price to $6 per unit and nothing else changes:

a) The firm's overall ROI will rise

b) The firm's overall ROI will fall

c) Division A's ROI will increase to 20%

d) The firm's overall ROI will remain unchanged

Solutions

Expert Solution

Since as per the given question - Division A sells its product to Division B only. ( No information on other sales other than Division B available).

Operating Profit of Division A when selling 100,000 units to Division B for $5 per unit = $150,000

Increase in profit of Division A when selling 100,000 unit to Division B for $6 per unit = $150,000 + [100,000 units * ($6-$5)] = $250,000

Current Profit of Division B = $250,000

Decrease in profit of Division B after increase in selling price by Division A for its product = $250,000 - [100,000 unit * ($6-$5)] = $150,000

ROI = Profits of the Company / Total Investment of the company

Current ROI of the Firm = ($150,000 + $250,000) / ($1,000,000 + $2,000,000) = 13%

There is an increase in the selling price of the product for Division A

Updated ROI of the firm = Updated Profits of the Divisions / Total Investment

= ($250,000 + $150,000) / ($1,000,000 + $2,000,000) = 13%

There is no change in the ROI of the firm, The answer to the question is option d -  The firm's overall ROI will remain unchanged

ekkarill92 answered 2 years ago
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