The Switch division of Tornax Inc. produces a small switch that is used by vario

Question

The Switch division of Tornax Inc. produces a small switch that is used by various companies as a component part in their products. Tornax operates its divisions as autonomous units, giving its divisional managers great discretion in pricing and other decisions. Each division is expected to generate a minimum required rate of return of at least 14% on its operating assets. The Switch Division has average operating assets of $700,000. The switches are sold for $5 each. Variable costs are $3 per switch, and fixed costs total $462,000 per year. The division has a capacity of 300,000 switches each year. Required: 1. How many switches must the Switch Division sell each year to generate the desired rate of return on its assets? Number of switches a. What is the margin earned at this level of sales? Margin b. What is the turnover at this level of sales? Turnover

Explanation / Answer

Contribution per unit = Sale Price Per Unit - Variable Cost per unit = 5-3 = $2

Return on Asset needed = 700,000*14% = $98,000

Fixed Cost = $462,000.

Total Contribution needed = $462,000+$98,000= $560,000

Number of Switches needed to generate the contribution = 560,000/2 = 280,00 Units.

Margin Earned at this Level = 280,000*2-460,000 = $98,000(i.e. the value of retrun on assets needed)

Total Turnover at 280,000 units = 280,000*5 = $1,400,000.

Margin = 98,000/1,400,000 = 7.00%.

2. If the sale price is increased by 4% - No of units sold = 280,000-20,000 = 260,000

Contribution = 260,000*2 = $520,000

Net Profit = $520,000 - $462,000 (Fixed cost) = $58,000

Asset Value reduced by 50,000 hence revised asset value = 700,000-50,000 = $650,000

Return on Investment/Asset = 58,000/650,000 = 8.92%

Turnover = 260,000 * 5 = $1,300,000.

Margin = 58,000/1,300,000 = 4.46%

3. If the sale price is reduced by 4% - No of units sold = 300,000 (capacity)

Contribution = 300,000*2 = $600,000

Net Profit = $600,000 - $462,000 (Fixed cost) = $138,000

Asset Value increased by 50,000 hence revised asset value = 700,000+50,000 = $750,000

Return on Investment/Asset = 138,000/750,000 = 18.40%

Turnover = 300,000 * 5 = $1,500,000.

Margin = 138,000/1,500,000 = 9.20%

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