Boots Company has two divisions. Land Division, which has operating assets of $8
ID: 2481339 • Letter: B
Question
Boots Company has two divisions. Land Division, which has operating assets of $80,000,000 produces and sells 900,000 units of a product at a market price of $140 per unit. Variable costs total $40 per unit. The division also assigns $70 of fixed costs to each unit based on total capacity of 1,000,000 units. Sea Division wants to purchase 200,000 units from Land. However, it is only willing to pay $80 per unit because it has an opportunity to accept a special order at a reduced price. The order is economically justifiable only if Sea Division can acquire Land Division’s output at a reduced price.
Boots Company’s cost of capital is 15%.
Required: PLEASE ANSWER ALL QUESTIONS.
1. What is the ROI for Land Division without the transfer to Sea Division?
2. What is Land Division’s ROI if it transfers 200,000 units to Sea Division at $80 each?
3. What is the minimum transfer price for the 200,000-unit order that Land would accept if it were willing to maintain the same ROI with the transfer as it would accept by selling its 900,000 units to the outside market?
4. What is the sales revenue at this transfer price?
5. What is the residual income for Land Division without the transfer to Sea Division? 6. What is Land Division’s residual income if it transfers 200,000 units to Sea Division at $80 each?
7. What is the minimum transfer price for the 200,000-unit order that Land would accept if it were willing to maintain the same residual income with the transfer as it would accept by selling its 900,000 units to the outside market?
8. If Land Division had no capacity constraints, what is the minimum transfer price it could accept on the order from Sea Division? Explain your answer.
9. If Land Division could sell all units produced to the outside market, what transfer price would you recommend? Why?
Explanation / Answer
1. What is the ROI for Land Division without the transfer to Sea Division?
The basic formula for ROI is: ROI = Net Profit / Total Investment * 100.
here, net profit = sales - variable cost - fixed cost
= (900,000*140) - (900,000*40)-(1,000,000*70)
=126,000,000-36,000,000-70,000,000 = 20,000,000
Total investment = operating assets = $80,000,000
Therefore, ROI = Net Profit / Total Investment * 100.
= 20,000,000 / 80,000,000 * 100 = 25% is the ROI
2. What is Land Division’s ROI if it transfers 200,000 units to Sea Division at $80 each?
here, net profit = sales - variable cost - fixed cost
= (700,000*140 + 200,000 * 80) - (900,000*40)-(1,000,000*70)
=(98,000,000 +16,000,000)-36,000,000-70,000,000
= 114,000,000 - 36,000,000 - 70,000,000 = 8,000,000
Therefore, ROI = Net Profit / Total Investment * 100.
= 8,000,000 / 80,000,000 * 100 = 10% is the ROI
3. What is the minimum transfer price for the 200,000-unit order that Land would accept if it were willing to maintain the same ROI with the transfer as it would accept by selling its 900,000 units to the outside market?
computation of transfer price = varoable cost + Opportunity cost is the revenue forgone
= 200,000 * 40 + 100,000 * 100 (i.e, 140sale price-40variable cost)
= 18,000,000 for 200,000 units = 18,000,000 / 200,000 = $90 is the transer price.
4. What is the sales revenue at this transfer price?
sales revenue = 800,000units * 140 + 200,000units * 90 = 112,000,000 + 18,000,000
=130,000,000 is the sales revenue.
5. What is the residual income for Land Division without the transfer to Sea Division?
calculation
amount
sales
900,000 * $140
126,000,000
less: variable cost
900,000 * $40
36,000,000
contribution
90,000,000
Less: fixed cost
-70,000,000
profit
20,000,000
6. What is Land Division’s residual income if it transfers 200,000 units to Sea Division at $80 each?
calculation
amount
sales
800,000 * $140 + 200,000 * 80
128,000,000
less: variable cost
900,000 * $40
36,000,000
contribution
92,000,000
Less: fixed cost
-70,000,000
profit
22,000,000
7. What is the minimum transfer price for the 200,000-unit order that Land would accept if it were willing to maintain the same residual income with the transfer as it would accept by selling its 900,000 units to the outside market?
to get the same residual income the trasfer price will be same as market price = $140
calculation
amount
sales
900,000 * $140
126,000,000
less: variable cost
900,000 * $40
36,000,000
contribution
90,000,000
Less: fixed cost
-70,000,000
profit
20,000,000
8. If Land Division had no capacity constraints, what is the minimum transfer price it could accept on the order from Sea Division? Explain your answer.
If theri is no capacity constrain, the minimum transefer price = variable cost = $40 per unit
here, Opportunity cost is zero since no outside sales are forgone as a result of making this internal sale.
9. If Land Division could sell all units produced to the outside market, what transfer price would you recommend? Why?
computation of transfer price = varoable cost + Opportunity cost is the revenue forgone
= 40 + 100( 140sale price-40variable cost) = $140 is the transer price.
calculation
amount
sales
900,000 * $140
126,000,000
less: variable cost
900,000 * $40
36,000,000
contribution
90,000,000
Less: fixed cost
-70,000,000
profit
20,000,000
calculation
amount
sales
900,000 * $140
126,000,000
less: variable cost
900,000 * $40
36,000,000
contribution
90,000,000
Less: fixed cost
-70,000,000
profit
20,000,000
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