Consider The Following Data Regarding Budgeted Operations

Consider The Following Data Regarding Budgeted Operations For 20x7 Of

Consider the following data regarding budgeted operations for 20x7 of the Portland division of Machine Products: average total assets $220,000; receivables $290,000; inventories $450,000; total $960,000. Fixed overhead is $300,000; variable costs are $1 per unit. The desired rate of return on average total assets is 25%. Expected volume is 150,000 units.

Questions:

1. a) What average unit sales price does the Portland division need to obtain its desired rate of return on average total assets?

   b) What would be the expected capital turnover?

   c) What would be the return on sales?

2. a) If the selling price is as previously computed, what rate of return will the division earn on total assets if sales volume is 170,000 units?

   b) If sales volume is 130,000 units?

3. 3) Assume that the Portland division plans to sell 45,000 units to the Calgary division of Machine Products and that it can sell only 105,000 units to outside customers at the price computed in requirement 1a. The Calgary division manager has balked at a tentative transfer price of $4. She has offered $2.25, claiming that she can manufacture the units herself for that price. The Portland division manager has examined his own data.

   He had decided that he could eliminate $60,000 of inventories, $90,000 of plant and equipment, and $22,500 of fixed overhead if he did not sell to the Calgary division and sold only 105,000 units to outside customers. Should he sell for $2.25? Show computations to support your answer.

Paper For Above instruction

Introduction

In managerial accounting, understanding the financial dynamics of a division's operations is crucial for strategic decision-making. The Portland division of Machine Products faces specific financial targets, including achieving a desired rate of return on its assets, setting appropriate selling prices, and making informed decisions about transfer pricing and sales volume impacts. This paper explores these aspects systematically, leveraging the provided data to compute necessary metrics and evaluate management decisions about sales strategies and transfer prices.

Required 1a: Determining the Necessary Average Unit Sales Price

The first step involves calculating the average unit sales price that enables the Portland division to achieve its targeted 25% return on its assets. The division's average total assets are valued at $220,000, and the desired return is 25%, equating to a return of $55,000 annually ($220,000 x 25%).

Given the anticipated volume of 150,000 units, the revenue must cover both fixed and variable costs, along with providing the desired profit. Fixed overhead costs are $300,000, and variable costs are $1 per unit, totaling $150,000 at the projected volume.

To attain the desired return, total revenue must be:

$220,000 (assets) x 25% (return rate) + fixed overhead + variable costs

which simplifies to:

Target profit: $55,000; Total fixed costs: $300,000; Variable costs: $150,000.

Therefore, total sales revenue (TR) needed is: TR = Fixed costs + Variable costs + Desired profit

TR = $300,000 + $150,000 + $55,000 = $505,000

Dividing this total by the expected units sold gives the needed selling price per unit:

Price per unit = $505,000 / 150,000 units ≈ $3.37

Thus, the Portland division must set an average unit sales price of approximately $3.37 to meet its financial goal.

Required 1b: Expected Capital Turnover

Capital turnover measures how efficiently the division uses its assets to generate sales, calculated as sales revenue divided by average total assets. The anticipated sales revenue at the computed price is:

Sales revenue = 150,000 units x $3.37 ≈ $505,500

The division's average total assets are $220,000; hence, the capital turnover ratio is:

Capital turnover = $505,500 / $220,000 ≈ 2.30 times

This indicates that the division expects to generate approximately $2.30 in sales for each dollar invested in assets, reflecting efficient use of its resources.

Required 1c: Return on Sales

Return on sales (ROS) assesses profitability relative to sales revenue. It is computed as operating income divided by sales. Operating income here is the target profit of $55,000. Using the total sales revenue of approximately $505,500:

ROS = $55,000 / $505,500 ≈ 10.87%

This suggests that the division aims for a profit margin of approximately 10.87% on its sales.

Required 2a: Return on Assets at Increased Sales Volume

If sales volume increases to 170,000 units, assuming the unit price remains $3.37, total sales revenue would be:

Revenue = 170,000 units x $3.37 ≈ $572,900

Fixed costs remain unchanged at $300,000, and variable costs increase proportionally:

Variable costs = 170,000 units x $1 = $170,000

The operating income now becomes:

Operating income = Revenue - Fixed costs - Variable costs = $572,900 - $300,000 - $170,000 = $102,900

The return on assets is:

ROI = Operating income / Total assets = $102,900 / $220,000 ≈ 46.77%

This significant increase reflects that higher sales volume substantially enhances profitability relative to asset investment.

2b: Return on Assets at Reduced Sales Volume

If sales fall to 130,000 units, revenue is:

Revenue = 130,000 units x $3.37 ≈ $438,100

Variable costs equate to:

Variable costs = 130,000 units x $1 = $130,000

Operating income becomes:

Operating income = $438,100 - $300,000 - $130,000 = $8,100

The ROI is thus:

ROI = $8,100 / $220,000 ≈ 3.68%

This demonstrates that a decline in sales volume drastically diminishes profitability and asset utilization efficiency.

Required 3: Evaluating Transfer Price for Sales to Calgary Division

When the Portland division considers selling 45,000 units to Calgary at a proposed transfer price of $2.25 per unit, it must evaluate whether this price covers its relevant costs and aligns with strategic profit maximization.

The division's data indicates that eliminating inventory, plant, and fixed overhead costs yields savings of $60,000, $90,000, and $22,500 respectively, totaling $172,500. If these reductions are realized, the actual cost per unit for the division (excluding the fixed overhead that can be eliminated) is calculated based on variable costs and opportunity costs.

The unit cost, considering variable costs and incremental costs, is $1 per unit, but the division must also consider the opportunity cost of selling internally versus externally and any potential savings from avoiding internal transfers.

Calculating the profitability at a transfer price of $2.25, the division's contribution margin per unit is:

Contribution per unit = $2.25 - $1 (variable cost) = $1.25

The total contribution from selling 45,000 units is:

Contribution = 45,000 x $1.25 = $56,250

Given the potential savings from not selling to Calgary, totaling $172,500, and the reduction in inventories and fixed overhead, it's crucial to compare the contribution margin with these savings.

If the division foregoes the sale at $4 to Calgary, it loses the contribution margin plus the savings. The net benefit from continuing internal sales at $2.25 can be evaluated against these potential gains.

Overall, since the division can eliminate costs of $172,500 and the contribution margin at $2.25 per unit is only $56,250, selling at this lower transfer price diminishes overall profit compared to internal sales at $4 or higher.

Therefore, unless internal strategic considerations override financial metrics, it would be more advantageous for the division not to accept the $2.25 transfer offer, considering the significant potential savings and lost contribution margins.

Conclusion

Analyzing the budgeted operations, pricing strategies, and internal transfer considerations reveals that the Portland division must set a unit price of approximately $3.37 to meet its 25% return on assets. Increased sales volumes improve ROI substantially, while lower sales significantly diminish profitability. Additionally, transfer price negotiations should align with cost savings and contribution margin analyses to ensure overall divisional profitability. Managers must carefully evaluate internal transfer offers not only based on immediate contribution but also considering potential cost savings and strategic implications beyond short-term profit.

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