CHAPTER 17

Management Control Systems and Transfer Pricing

CHAPTER LEARNING OBJECTIVES
1. Describe the qualities of an effective management control system.
2. Explain how the four types of responsibility centers work: cost center, revenue center,
profit center, and investment center.
3. Measure the performance of investment centers.
4. Explain how cost-based, market-based, and negotiated transfer pricing methods work.

Current count is:

Knowledge: 24
Comprehension: 24
Application: 41
Analysis: 44
Evaluation: 8
Synthesis: 0
Total: 141

Number and percentage of questions:

Easy: 14 questions, 10 percent (target of 25%)
Medium: 100 questions, 71 percent (target of 65%)
Hard: 27 questions, 19 percent (target of 10%)

Question types:
Multiple Choice: 110
Short Answer: 6
Brief Exercises: 12
Exercises: 10
Problems: 3
 Multiple-Choice Questions

1. Management control systems can typically be placed into one of two broad categories:
Centralized or Decentralized. While most businesses may start as centralized, they may shift
towards a decentralized system over time. Which of the following would be considered a benefit
of a decentralized system?
a. Duplication of activities
b. Faster decision-making
c. Less responsiveness to local needs
d. Less specialization
Ans: B, LO 1, Bloom: K, Difficulty: Easy, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with the general advantages and disadvantages of a decentralized management system. Choices A, C, and
D all represent drawbacks or incorrect representations of the benefits of a decentralized system. Choice B is correct as faster decision-making is
considered a benefit of a decentralized management system.

2. Management control systems can typically be placed into one of two broad categories:
Centralized or Decentralized. While most businesses may start as centralized, they may shift
towards a decentralized system over time. Which of the following would be considered a
drawback of a decentralized system?
a. Duplication of activities
b. More specialization
c. Optimal decision-making
d. Slower decision-making
Ans: A, LO 1, Bloom: K, Difficulty: Easy, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with the general advantages and disadvantages of a decentralized management system. Choices B, C, and
D all represent benefits or incorrect representations of drawbacks of a decentralized system. Choice A is correct as duplication of activities is
considered a drawback of a decentralized management system.

3. In an effort to optimize decentralization, work towards accomplishing its mission, and achieve
goal-congruence, an organization will strive to utilize a lot of planning in the design and
implementation of their management system. Which of the following represents one of the four
pillars of management control systems?
a. Irresponsibility centers
b. Performance measurement
c. Production
d. Unit pricing
Ans: B, LO 1, Bloom: K, Difficulty: Easy, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with the four pillars of management control systems. Choices A, C, and D represent incorrect choices as
they are not included in the four pillars or do not exist at all. Choice B is the correct choice because performance measurement is one of the four pillars
of management control systems.

4. As companies become established and shift from a centralized to a decentralized business

model, employees start to become empowered to own and manage certain processes. While
this comes with its own set of implementation challenges initially, it is usually considered
worthwhile in the long run. Which of the following represents a benefit of decentralization?
a. Certain activities are likely to be duplicated, and that can mean that money will be
saved as the work gets completed faster.
b. Increased levels of management mean the turnaround times for approvals will
decrease.
c. Managers will likely show more initiative when they have the authority to make
decisions for their own business unit.
 d. The company increases its ability to place employees and managers in areas where
they are not currently specialized.
Ans: C, LO 1, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with the benefits of decentralized management systems. While some of the choices above appear
to be correct, there is one aspect of three choices that makes the option either inaccurate or a drawback. Choice C is the only one of the four that
represents a true benefit of a decentralized management system.

5. As companies become established and shift from a centralized to a decentralized model,

employees start to become empowered to own and manage certain processes. While this
comes with its own set of implementation challenges initially, it is usually considered worthwhile
in the long run. Even so, there could be some drawbacks to this type of management system.
Which of the following represents a drawback of decentralization?
a. Certain activities are likely to be duplicated across departments, and that can mean
that money will be wasted.
b. High-level managers find they have increased distance from day-to-day operations
and now have greater freedom to think strategically.
c. Managers will likely show less initiative when they are in control and have the
authority to make decisions for their own business unit.
d. The organization chart is likely to take on a wide but shallow appearance from top-to-
bottom indicating increased bureaucracy.
Ans: A, LO 1, Bloom: K, Difficulty: Easy, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires that familiarity with the drawbacks of decentralized management systems. While some of the choices above appear to
be correct, there is one aspect of three choices that makes the option either inaccurate or not a drawback. Choice A is the only one of the four that
represents a true drawback of a decentralized management system.

6. In a well-structured organization, management will strive to achieve goal congruence. While

managers may find that they are being evaluated on the performance of their own business unit,
the overall congruence of goals must be kept in mind when setting objectives for these
managers. Which of the following represents an optimal outcome that is aligned with the
company-wide objective of saving money for short and long-term future goals?
a. Sanford, the plant manager, knows that a large machine needs to be replaced in
order to get orders done on time, but Sanford chooses not to replace the machine as
this is not in his budget for the year.
b. Susan, a manager, makes her employees clock-out during the last fifteen minutes of
their shifts, but they must stay and complete their work to help the company save on
expenses.
c. Teresa, an assembly line worker, has advocated for her department to hire an
occupational therapist to evaluate repetitive work injuries and reduce sick time used
to recover from these on-the-job injuries.
d. Trent, a production employee, chooses to donate some of his unused sick time to a
fellow employee so the company will not penalize the department for having to cover
that employee’s short-term leave.
Ans: C, LO 1, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with goal congruence and how managers can set goals that either do or do not align with overall
company objectives. Choice C is the only choice that presents an optimal outcome that is also aligned with the company-wide objective of saving
money in an ethical manner. Although hiring an occupational therapist costs money, it will save money for the company as people are able to avoid
injuries and not miss time at work or incur large medical expenses that would impact employee insurance rates for the organization.

7. In a well-structured organization, management will strive to achieve goal congruence. While

managers may find that they are being evaluated on the performance of their own business unit,
the overall congruence of goals must be kept in mind when setting objectives for these
 managers. Which of the following represents a suboptimal outcome that is misaligned with the
company-wide objective of saving money?
a. Sanford, the plant manager, knows that a large machine needs to be replaced in
order to get orders done on time, but Sanford chooses not to replace the machine
since this was not in his budget for the year.
b. Susan, a manager, makes her employees clock-out during the last fifteen minutes of
their shifts, but they must stay to complete their work to help the company save on
expenses.
c. Teresa, an assembly line worker, has advocated for her department to hire an
occupational therapist to evaluate repetitive work injuries and reduce sick time used
to recover from these on-the-job injuries.
d. Trent, a production employee, chooses to donate some of his unused sick time to a
fellow employee so that the company will not penalize the department for having to
cover that employee’s short-term leave.
Ans: A, LO 1, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with goal congruence and how managers can set goals that either do or do not align with overall
company objectives. Choice A is the only choice of the four that presents a suboptimal outcome that is misaligned with the company-wide objective of
saving money. This choice is suboptimal, and it is unlikely to save the company any money. While some of the options are also suboptimal in their
execution, they do align with the company goal of cutting expenses albeit unethically.

8. When an organization wants to optimize decentralization, achieve goal-congruent outcomes,

and accomplish its mission, management will look to implement a well-designed and well-
planned management control system. A system such as this will utilize the four pillars of
management control systems to achieve a major impact on employee behavior. Which of the
following is an example of the proper usage of one of the pillars?
a. Allowing managers to spend money as it is needed as long as they have an
accountable plan and submit their receipts and paperwork in a timely fashion
b. Dividing up work and responsibilities for the company into smaller departments with
their own assigned manager
c. Encouraging a department to sell to another internal department at any price they
feel is fair, even if it surpasses the current market rate
d. Setting a performance goal for management of a 50% increase in sales when a 10%
increase in sales has been realized historically.
Ans: B, LO 1, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with the four pillars of management and how they can be used to create a well-designed
management control system. Choice B is the only choice of the four that appropriately uses one of the four pillars to improve their system. The other
three options are likely to lead to a suboptimal outcome as they are not created to improve any existing operations.

9. When an organization wants to optimize decentralization, achieve goal-congruent outcomes,

and accomplish its mission, management will look to implement a well-designed and well-
planned management control system. A system such as this will utilize the four pillars of
management control systems to achieve a major impact on employee behavior. Which of the
following is an example of an improper usage of one of the pillars?
a. Asking all new employees to do any physical labor-intensive work to give more
senior employees a break, regardless of their department
b. Asking management to create a formalized budget based on historical data for their
department
c. Creating a logical and methodical system for determining the transfer price between
two internal departments
d. Having yearly performance measurement for management based on department-
specific benchmarks
 Ans: A, LO 1, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with the four pillars of management and how they can be used to create a well-designed
management control system. Choice A is the only choice of the four above that improperly uses one of the four pillars to improve their system. By
dividing up work by a class of people rather than implementing a logical division of work that does not target one specific group, this is an improper use
of the pillars. The other three options are likely to lead to an optimal outcome as they are created to improve existing operations.

10. A large public University has been undergoing some changes as it attempts to modernize and
adopt a more online-friendly learning environment. The University has decided that one step that
must be taken is to decentralize its operations. Previously, the President of the University was
charged with making all decisions ranging from final say on supply purchases to hiring decisions.
Which of the following examples shows a way that the University might successfully decentralize?
a. Deans are assigned to each college and are permitted to make college-specific
decisions.
b. The Basketball Coach has been instructed to request final approval from the
University Vice President after an initial selection of players is complete.
c. The President is responsible for overseeing the administrative staff for the College of
Fine Arts.
d. The President will have the final say on all faculty hires rather than each College’s
Dean.
Ans: A, LO 1, Bloom: K, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with the concept of decentralization and how to apply it in a specific scenario. Choice A is the only choice of the
four that shows the successful decentralization of this University. By allowing Deans who specialize in specific areas to run their own colleges, the University
allows decisions to be made that will be in line with the overall goals of the organization. These disciplines can be nuanced and require someone who is
intimately familiar to make these decisions. The other three choices are examples of centralization and will not achieve the goal of decentralization.

11. A large public University has been undergoing some changes as it attempts to modernize and
adopt a more online-friendly learning environment. The University has decided that one step that
must be taken is to decentralize its operations. Previously, the President of the University was
charged with making all decisions ranging from final say on supply purchases to hiring decisions.
Which of the following is an example of an unsuccessful attempt to decentralize?
a. Central executives will be placed in charge of recruiting and hiring faculty for all
colleges and disciplines.
b. Faculty will be permitted to select teaching assistants for their courses.
c. Newly created Dean positions allow for a person to make college-specific decisions
without having to await approval from an executive.
d. The football coach will make the final decision on which players make the team after
initial tryouts.
Ans: A, LO 1, Bloom: K, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with the concept of decentralization and how to apply it in a specific scenario. Choice A is the only choice of the
four that shows an unsuccessful attempt at implementing decentralization at this University. By allowing executives to make recruiting and hiring decisions of
faculty for all colleges and disciplines, the needs of each discipline and the students at each college are not likely to be fully understood or taken into
consideration. The other three choices are examples of successful decentralization.

12. Recently, a manager at a grocery store voiced concerns that the higher-ups have set completely
unrealistic goals that the store can in no way achieve this year. This manager fears that the
pressure of trying to succeed may lead some employees to make unethical decisions in order to
achieve the unrealistic goals. Management and employees are evaluated on their abilities to meet
these goals. Which of the following is an example that is indicative of unethical behavior that might
be employed by someone to meet unrealistic goals?
a. A cashier has been ringing up some items twice when checking a customer out even
though one of those items was purchased by the customer.
b. A manager has been working extra hours without clocking in to increase revenue
and decrease labor costs.
 c. An employee noticed that a coworker has been taking bottled drinks without paying
while on their break.
d. Management has implemented a new membership program that costs $50 per year
and would give some customers preferential treatment.
Ans: A, LO 1, Bloom: K, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with ways that setting unrealistic goals on which performance is measured is not a proper implementation of one
of the four management pillars. Choice A is the only choice that is an unethical behavior that is also trying to achieve the goal of increasing sales. The other
three choices are in some cases unethical, but they do not aim to increase sales or are ethical and try to increase revenue.

13. Recently, a manager at a grocery store voiced concerns that the higher-ups have set completely
unrealistic goals that the store can in no way achieve this year. This manager fears that the
pressure of trying to succeed may lead some employees to make unethical decisions in order to
achieve the unrealistic goals. Management and employees are evaluated on their abilities to meet
these goals. Which of the following is an example that is indicative of ethical behavior that might be
employed by someone to meet sales goals?
a. A cashier has been asking customers to round up their totals to give the excess
funds to a charity.
b. A manager has been asking the employees to work extra hours without clocking in to
increase revenue and decrease labor costs.
c. Cashiers have been encouraged to ask customers if they would like to sign up for a
store credit card.
d. Management has approved a new customer incentive program where customers will
receive a discount coupon for a future visit by spending a certain amount today.
Ans: D, LO 1, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with the way that setting unrealistic goals on which performance is measured is not a proper implementation of
one of the four management pillars. Choice D is the only choice that is an ethical behavior that is also trying to achieve the goal of increasing revenue. The
other three choices are in some cases ethical, but they do not aim to increase sales or are unethical and try to increase sales.

14. As organizations grow and move towards a decentralized model, one goal will often be to empower
employees. One way that this is accomplished is by creating responsibility centers and assigning
managers to oversee the operations of their particular area of expertise. Which of the following best
represents an accurate representation of a responsibility center?
a. John is overseeing the production department at his job, and he must create a
budget to implement for the upcoming year.
b. Sarah has been promoted to manage the maintenance team at a local hotel, but she
must get approval for all hiring through the company president.
c. The CEO of the company has decided to oversee the customer service department
since they do not trust the current manager of the department.
d. The president of the organization will oversee all business units and delegate few
tasks to managers.
Ans: A, LO 2, Bloom: K, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with the way that responsibility centers work and how they are set up. Choice A is the only choice of the four that
describes an accurate representation of what a responsibility center should be. Choice A exemplifies a person who is assigned to run a business unit and is
making decisions at their own discretion. The other three choices do not represent an appropriate use of a business unit where a manager is in charge of
one area and can delegate tasks as needed.

15. As organizations grow and move towards a decentralized model, one goal will often be to empower
employees. One way that this is accomplished is by creating responsibility centers and assigning
managers to oversee the operations of a particular area of expertise. Which of the following
represents an inaccurate representation of a responsibility center?
a. Aliyah, an owner and president of a retail store, appoints John to be the manager of
the garden center at the store.
 b. Arthur oversees the marketing department for a local sports bar, and he asks
another employee to work on social media posts.
c. Samantha, a manager, runs the payroll processing department and reports to a
regional manager.
d. The president of the organization will oversee all business units and delegate few
tasks to managers.
Ans: D, LO 2, Bloom: K, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with the way that responsibility centers work and how they are set up. Choice D is the only choice of the four that
describes an inaccurate representation of what a responsibility center should be. Choice D is more in line with what would be observed in a centralized
management system where business units are not used. The other three choices represent an appropriate use of a business unit where a manager is in
charge of one area and can delegate tasks as needed.

16. All business units are created with certain goals against which they are measured. Regardless of
the type of business unit, evaluations are utilized to ensure that management is directing the team
towards the achievement of goals that are congruent with the overall company goals set forth by
the highest levels of management. Which of the following best represent metrics used to evaluate a
profit center?
a. Return on Investment, Sales Mix, Dollar Value of Sales
b. Target Profit, Budget-to-Actual Profit Reports, Net Income
c. Target Profit, Dollar Value of Sales, Return on Investment
d. Year-to-Date Expenditures, Return on Sales, Residual Income
Ans: B, LO 2, Bloom: K, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with the evaluation of various responsibility centers. Choice B is the only choice of the four options that represent
metrics that would be used to evaluate a profit center. The other choices are a mixture of metrics used to evaluate a profit center or other types of
responsibility centers.

17. Decentralized organizations have the ability to create divisions of itself that are called responsibility
centers. One of the features and advantages of this is that managers have decision-making
independence and are empowered to run their own departments. Which of the following best
represents the presence of authority, one of the three characteristics of a responsibility center?
a. A company moves from a model where a department is able to set working hours for
its employees to a company-wide policy for all employees.
b. Carleigh, the divisional manager delegates analysis tasks to his employees and has
the decision-making authority to purchase assets for his division.
c. The company CEO insists that they must approve any new hires selected by the
accounting department.
d. The sales manager decides not to delegate paperwork to subordinates so that they
can monitor all activity.
Ans: B, LO 2, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with authority, one of the three characteristics of a responsibility center. Choice B is the only one of the four
choices that accurately depicts the presence of authority by allowing a divisional manager to delegate tasks and make decisions that will immediately impact
their department and eventually the company as well. The other three choices represent a lack of authority where higher-level executives have not allowed
the department to have the authority or ability to make decisions independent of them.

18. Decentralized organizations have the ability to create divisions of itself that are called responsibility
centers. One of the features and advantages of this is that managers have decision-making
independence and are empowered to run their own departments. Which of the following represents
the lack of authority, one of the three characteristics of a responsibility center?
a. A bank branch manager has delegated the task of signing off on new accounts to
lower-level employees.
b. A company moves from a model where there is a company-wide policy for set
working hours to one where each department can determine what hours employees
will work.
 c. A hospital CEO would like to oversee the hiring of all nursing staff since they believe
the manager has allowed too much turnover.
d. The sales manager has asked senior-level sales staff to take charge of the inventory
count beginning next month.
Ans: C, LO 2, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with authority, one of the three characteristics of a responsibility center. Choice C is the only one of the four
choices that accurately depicts the lack of authority by allowing the CEO to make a hiring decision for a specific department and not trusting in the manager
to make this important decision. The other three choices represent the presence of authority where managers of a department have the authority or ability to
make decisions independent of higher-level management.

19. One of the largest differences between a centralized and decentralized organization is the division
of power. In a decentralized organization, power is given to managers of individual departments or
business units. Responsibility is one of the three characteristics of a responsibility center. Which of
the following best represents the delegation of responsibility within a decentralized organization?
a. Bobby is a sales associate who was just asked to assume responsibility for checking
out guests but has not received any instruction regarding what needs to be done.
b. Sharon, the manager of the research department, has tasked a research assistant
with doing an equipment inventory count each month and takes timely updates to be
sure task is done.
c. The company CEO decides that they will continue to oversee the production
department but places all responsibility for sales outcome on the department
manager.
d. The women’s clothing manager of a retail store has assumed responsibility for
overseeing the men’s department, delegated folding to a sales associate, but has not
requested an update.
Ans: B, LO 2, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with responsibility, one of the three characteristics of a responsibility center. Choice B is the only one of the four
choices that accurately depicts the implementation of responsibility since the manager has not only delegated a task but also taken steps to ensure that task
is completed. The other three choices represent a lack of responsibility where higher-level executives and managers have not correctly or fully implemented
responsibility.

20. In a decentralized organization, business units are created to better achieve a sense of
independence amongst management. In a business unit, management is responsible for ensuring
that tasks in their department are being completed and for overseeing their subordinates. One of
the three main characteristics of a decentralized organization is accountability, which means that
one will have to answer for the job when it is done. Which of the following best represents the
existence of accountability in an organization?
a. A manager in charge of the product design team asked a lower-level associate to
order supplies that are needed by the department to function. She is busy and did
not follow up and ending up placing the order herself when supplies were about to
run out.
b. A new office assistant was asked to check the company voicemail in the morning but
has neglected to do it, so messages were missed.
c. A pharmaceutical sales representative does not submit a mileage report for the week
and is denied a reimbursement by the manager for not following protocol.
d. The maintenance person was asked in passing by a manager to hang updated
workplace safety posters and forgot to follow up.
Ans: C, LO 2, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with accountability, one of the three characteristics of a responsibility center. Choice C is the only one of the four
choices that accurately depicts the existence of accountability since the sales representative was held accountable for not following the assigned protocol.
This choice impacts their department and the company overall. The other three choices represent a lack of accountability from the managers for the
subordinates.
21. In a decentralized organization, business units are created to better achieve a sense of
independence amongst management. In a business unit, management is responsible for ensuring
that tasks in their department are being completed and for overseeing their subordinates. One of
the three main characteristics of a decentralized organization is accountability, which means that
one will have to answer for the job when it is done. Which of the following represents the non-
existence of accountability in an organization?
a. A paralegal has been issued a warning after neglecting to file some documents with
the courts that will delay the trial her manager is involved with.
b. A receptionist was in charge of submitting the sales department timesheets and was
reprimanded by a manager when this was not completed.
c. A staff accountant was asked by their manager to come in over the weekend to
complete the work the accountant had overlooked that had a deadline of the Friday
before.
d. The manager of the production department has decided to make the task of cleaning
the employee bathroom a volunteer-based task rather than assigning it to one
employee.
Ans: D, LO 2, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with accountability, one of the three characteristics of a responsibility center. Choice D is the only one of the four
choices that accurately depicts the non-existence of accountability since the task of cleaning the bathroom has not been assigned to anyone, leaving
accountability for that task out of the picture. This choice impacts their department and the company overall. The other three choices represent the existence
of accountability in the organization.

22. A decentralized organization will have various responsibility centers including revenue centers,
whose sole purpose is to generate revenue. These centers will also incur the cost of having
employees work there, but their goal is to generate sales and hit targets set by management. Of
the following examples, which best represents a revenue center?
a. Housekeeping at a small hotel
b. Payroll processing at a local bank
c. Sales department at an HVAC company
d. The pharmacy at a local grocery store
Ans: C, LO 2, Bloom: K, Difficulty: Easy, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with responsibility centers and how the types of centers differentiate from one another. A revenue center will
incur costs but is measured on its ability to generate revenue and hit targets. Choice C is the only choice listed that is a true revenue center. Choices A,
B, and D all represent other types of centers.

23. A large home improvement retail company is moving towards a decentralized management
system from a centralized system after years in business. They are aware that this will entail
generating various responsibility centers and placing the appropriate people in charge. Which of
the following would be considered a profit center for the company?
a. The garden center in the store
b. The home projects consulting department
c. The janitorial department
d. The payroll department
Ans: A, LO 2, Bloom: K, Difficulty: Easy, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with responsibility centers and how the types of centers differentiate from one another. A profit center will
make sales and incur costs and is measured on its ability to hit sales goals while also managing its expenses and achieving a certain amount of profit.
Choice A is the only choice listed that is a true profit center. Choices B, C, and D all represent other types of centers.

24. A boutique hotel is in the process of upgrading all of its systems including its management
control system. Since its inception, the hotel has employed a centralized system, but the hotel
has grown enough to consider decentralization. Of the following units or departments, which
would be considered a cost center for the boutique hotel?
 a. Food and beverages department
b. The gift shop
c. The hotel bar
d. The housekeeping department
Ans: D, LO 2, Bloom: K, Difficulty: Easy, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with responsibility centers and how the types of centers are different from one another. A cost center will
incur costs and is measured on its ability to manage its expenses while also controlling certain nonfinancial metrics. Choice D is the only choice listed
that is a true cost center. Choices A, B, and C all represent other types of centers.

25. Some organizations choose a responsibility center to focus on selecting assets to reach a target
return and then putting those profits back into the business or other assets. Certain
organizations have done this to great success including Amazon, Netflix, and the New York
Yankees. Which of the following best represents the most accurate responsibility center as
described?
a. Cost Center
b. Investment Center
c. Profit Center
d. Revenue Center
Ans: B, LO 2, Bloom: K, Difficulty: Easy, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with responsibility centers and how the types of centers are different from one another. An investment center
will focus on selecting assets to generate a target return that it will then reinvest with the goal of earning more. Choice B is the choice that correctly
identifies an investment center as the kind of responsibility center described in the problem. Choices A, C, and D all represent other types of centers
that do not fit this description.

26. One of the largest differences between a centralized and decentralized organization is the
division of power. In a decentralized organization, power is given to managers of individual
departments, or business units. Responsibility is one of the three characteristics of a
responsibility center. Which of the following best represents the absence of delegation of
responsibility within a decentralized organization?
a. Laura, the night clerk at a hotel, has been covering all of the phones as instructed
since the manager believes Laura is ready to learn some additional skills.
b. The company CEO decides that they will continue to oversee the production
department but places all responsibility for sales outcomes on the department
manager.
c. The company CEO implements a new policy where managers will be responsible for
all departmental budget information for areas they oversee.
d. The men’s clothing manager of a retail store has delegated cash register duties to a
new sales associate and has followed up to ensure the task is being completed.
Ans: B, LO 2, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with responsibility, one of the three characteristics of a responsibility center. Choice B is the only
one of the four choices that accurately depicts the absence of delegation of responsibility since the manager has not only delegated a task to Jeremy
that he is not qualified to handle but also due to the reason this task was delegated. The other three choices represent a lack of responsibility where
higher-level executives and managers have correctly and/or fully implemented responsibility.

27. Turner Inc. is a factory that creates laptop bags that contain an added sleeve for increased
protection. The sewing department is currently debating on the best way to proceed with
sourcing the materials needed to create the end product. What is most likely to impact a
potential price with an internal department?
a. The maximum selling price established by the seller of the product
b. The minimum price that would be established by the buyer of the product
c. Whether the internal department has any idle capacity or not as this would impact
the minimum acceptable transfer price
d. Whether the managers of the departments have good peer-to-peer relationship
 Ans: C, LO 2, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with how internal transfer pricing could be established and what impact that would have on the
potential price that is determined. Choice C is the best example of something that would be most likely to impact an internal price. When a department
has idle capacity, they will establish a minimum acceptable transfer price that is different than a department that does not have idle capacity. The other
choices are either less likely or unlikely to impact the price for an internal sale.

28. Jones Enterprises is evaluating their divisions over the past few months to determine what
department has done the most effective job at meeting or exceeding the Return on Investment
(ROI) metric of 16% required by the company. They begin by looking at Sheila’s division which
purchased a new machine in the last year. This large piece of equipment cost $9,000,
generated $3,420 of sales, and incurred $1,904 of operating expenses. Given this information,
what is the profit margin of this new equipment, and was this a successful decision?
a. No, this would not be considered successful with a negative return of $0.44.
b. No, this would not be considered successful with a negative return of $0.80.
c. Yes, this would be considered successful with a positive return of $0.44.
d. Yes, this would be considered successful with a positive return of $0.80.
Ans: C, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for profit margin: Operating Income divided by Sales. In
this question, the cost of the equipment is not relevant. To calculate the profit margin, first solve for Operating Income: Sales – Operating Expenses =
$3,420 – $1,904 = $1,516. Now, divide this number by Sales = $1,516/$3,420 = 0.4433 or $0.44 is left over as Operating Income or return. This would
be considered successful as the purchase of new equipment generated a positive return (Choice C).

29. Jones Enterprises is evaluating their divisions over the past few months to determine what
department has done the most effective job at meeting or exceeding the Return on Investment
(ROI) metric of 16% required by the company. They begin by looking at Sheila’s division, which
purchased a new machine in the last year. This large piece of equipment cost $9,000,
generated $3,420 of sales, and incurred $1,904 of operating expenses. Given this information,
what is the ROI of this new equipment, and was this a good decision made by Sheila?
a. No, this would not be considered a good decision with a negative return of 16.84%.
b. Yes, this would be considered a good decision with a positive return of 16.84%.
c. Yes, this would be considered a good decision with a positive return of 21.16%.
d. Yes, this would be considered a good decision with a positive return of 28.63%.
Ans: B, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for ROI: (Operating Income/Sales) times
(Sales/Investment). The Sales cancel out, leaving: Operating Income/Investment = ($3,420 – $1,904)/$9,000 = $1,516/$9,000 = 16.84%. The company
requires at least a 16% ROI for each division, and it appears that Sheila made a good decision (Choice B).

30. The printing division at a small factory is in need of a new printer and is currently comparing
their choices. They have narrowed it down to two options:
Machine 1 Machine 2
Cost $12,000 $9,500
Estimated Sales $ 3,400 $2,200
Operating Expenses (including depreciation) $ 1,100 $ 800

Which machine will have the higher investment turnover based on the information provided?
(Do not round intermediate calculations.)
a. Machine 1’s investment turnover is higher than Machine 2’s by 4.43%.
b. Machine 1’s investment turnover is higher than Machine 2’s by 5.18%.
c. Machine 2’s investment turnover is higher than Machine 1’s by 4.43%.
d. Machine 2’s investment turnover is higher than Machine 1’s by 5.18%.
Ans: B, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for Investment Turnover: Sales/Investment. Machine 1:
 $3,400/$12,000 = 0.2833, and Machine 2: $2,200/$9,500 = 0.2316. Now, calculate the difference in investment turnover by subtracting the value for
Machine 2 from the value from Machine 1 = 0.2833 – 0.2316 = 0.0518. Machine 1 has a higher Investment turnover by 0.0518 or 5.18% when
compared to Machine 2 (Choice B).

31. The printing division at a small factory is in need of a new printer and is currently comparing
their choices. They have narrowed it down to two options:

Machine 1 Machine 2
Cost $12,000 $9,500
Estimated Sales $ 3,400 $2,200
Operating Expenses (including depreciation) $ 1,100 $ 800

What is the difference in Return on Investment between the two machines based on the
information provided? (Do not round intermediate calculations.)
a. Machine 1 has an ROI that is 4.43% higher than Machine 2.
b. Machine 1 has an ROI that is 4.43% lower than Machine 2.
c. Machine 1 has an ROI that is 5.17% higher than Machine 2.
d. Machine 1 has an ROI that is 5.17% lower than Machine 2.
Ans: A, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for ROI: (Operating Income/Sales) times
(Sales/Investment). The sales will cancel out, leaving: Operating Income/Investment. Now, calculate this value for each machine. Machine 1: ($3,400 –
$1,100)/$12,000 = 19.17%, and Machine 2: ($2,200 – $800)/$9,500 = 14.74%. Now, find the difference between the two ROIs by subtracting Machine
2’s value from Machine 1’s value. 19.17% – 14.74% = 4.43% higher ROI for Machine 1 (Choice A).

32. A clothing company would like to purchase a new piece of equipment and has been debating
the purchase of either (a) a new sewing machine that would improve the existing department or
(b) an embellisher that would afford the company the opportunity to add new and unique
clothing to their existing lines. They gathered the following prospective information:
Sewing Machine Embellisher
Cost $3,420 $4,808
Useful Life 10 years 8 years
Estimated Sales $5,430 $6,280
Operating Expenses (excluding depreciation) $ 902 $1,176

Which machine choice yields the highest profit margin and by how much? (Do not round
intermediate calculations.)
a. The embellisher has a 2.12% higher profit margin than the sewing machine.
b. The embellisher has a 5.39% higher profit margin than the sewing machine.
c. The sewing machine has a 2.12% higher profit margin than the embellisher.
d. The sewing machine has a 5.39% higher profit margin than the embellisher.
Ans: D, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires the formula for calculating Profit Margin: Operating Income divided by Sales. After
calculating this figure for each machine, compare them to determine which has the highest profit margin. The operating expenses for each are
incomplete, so calculate the depreciation expense. Sewing Machine: $3,420/10 years = $342 per year. Total Operating Expenses = $902 + $342 =
$1,244. Embellisher: $4,808/8 years = $601. Total Operating Expenses = $1,176 + $601 = $1,777. Now, calculate profit margin for each. Sewing
Machine: ($5,430 – $1,244)/$5,430 = 0.7709. Embellisher: ($6,280 – $1,777)/$6,280 = 0.7170. Now, compare the two: 0.7709 – 0.7170. The sewing
machine has a 0.0539 or 5.39% higher profit margin than the embellisher (Choice D).

33. A clothing company would like to purchase a new piece of equipment and has been debating
the purchase of either (a) a new sewing machine that would improve the existing department or
(b) an embellisher that would afford the company the opportunity of adding new and unique
clothing to their existing lines. They have gathered the following prospective information:
 Sewing Machine Embellisher
Cost $3,420 $4,808
Useful Life 10 years 8 years
Estimated Sales $5,430 $6,280
Operating Expenses (excluding depreciation) $ 902 $1,176

What is the Return on Investment (ROI) for each choice?

a. Sewing Machine: 93.66%, Embellisher: 122.4%
b. Sewing Machine: 106.16%, Embellisher: 132.4%
c. Sewing Machine: 122.40%, Embellisher: 93.66%
d. Sewing Machine: 132.40%, Embellisher: 106.16%
Ans: C, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires the formula for calculating Return on Investment: Operating Income divided by
Investment. The operating expenses for each are incomplete, so calculate the depreciation expense. Sewing Machine: $3,420/10 years = $342 per
year. Total operating expenses = $902 + $342 = $1,244. Embellisher: $4,808/8 years = $601 per year. Total operating expenses = $1,176 + $601 =
$1,777. Now, calculate ROI for each. Sewing Machine: ($5,430 – $1,244)/$3,420 = 1.2240 or 122.40%. Embellisher: ($6,280 – $1,777)/$4,808 =
0.9366 or 93.66% (Choice C).

34. Sacha works for an organization that follows a decentralized model. Erin, the production
manager of her business unit has come to Sacha to discuss the possibility of purchasing a new
piece of equipment. Erin indicated that this new equipment could generate $23,500 of sales,
and the expenses (after depreciation) to support it would be 70% of the new sales. After
speaking to a supplier, Erin learns that the new equipment can be purchased for $15,750. What
are the Profit Margin and the Investment Turnover for the new equipment?
a. Profit Margin: 0.30, Investment Turnover: 1.492
b. Profit Margin: 0.70, Investment Turnover: 1.044
c. Profit Margin: 1.044, Investment Turnover: 0.70
d. Profit Margin: 1.492, Investment Turnover: 0.30
Ans: A, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: To answer this question, calculate both the Profit Margin and the Investment Turnover. Profit Margin is:
Operating Income/Sales. Operating Income = $23,500 – ($23,500 × 70%) = $23,500 – $16,450 = $7,050. Profit Margin = $7,050/$23,500 = 0.30.
Investment Turnover = Sales/Investment = $23,500/$15,750 = 1.492 (Choice A).

35. Sacha works for an organization that follows a decentralized model. Erin, the production
manager of her business unit has come to Sacha to discuss the possibility of purchasing a new
piece of equipment. Erin has indicated this new equipment could generate $23,500 of sales, and
the expenses (after depreciation) to support it would be 70% of the new sales. After speaking to
a supplier, Erin learns that the new equipment can be purchased for $15,750. What is the
Return on Investment for the new equipment?
a. 30.00%
b. 44.76%
c. 95.74%
d. 104.44%
Ans: B, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: To answer this question, use the Return on Investment (ROI) formula: Operating Income/Investment. It is
important to note that Sales is a part of the DuPont method but cancels itself out, leaving the aforementioned formula. Operating Income = $23,500 –
($23,500 × 70%) = $23,500 – $16,450 = $7,050. Now, calculate the ROI: $7,050/$15,750 = 0.4476 or 44.76% (Choice B).

36. The Riggs Company manufactures monogrammed t-shirts that are sold online. The manager of
one of the business units would like to consider replacing their current embroidery machine and
has a choice between buying either (a) a brand new one for $12,840 or (b) a refurbished model
for $9,703. The new machine will incur $4,906 of expenses, and the refurbished machine will
 incur $4,677 of expenses. Both machines will have a Return on Investment (ROI) of 9%. How
much Sales will the new machine generate? (Do not round calculations.)
a. $1,155.60
b. $5,550.27
c. $5,832.60
d. $6,061.60
Ans: D, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This formula requires knowledge of the formula for ROI: Operating Income/Investment. To begin, plug-in the
information provided: 0.09 = (X – $4,906)/$12,840. Now, solve for X: $1,155.60 = X – $4,906, so X = $6,061.60. The new machine will generate
$6,061.60 of Sales (Choice D).

37. The Riggs Company manufactures monogrammed t-shirts that are sold online. The manager of
one of the business units would like to consider replacing their current embroidery machine and
has a choice of buying either (a) a brand new one for $12,840 or (b) a refurbished model for
$9,703. The new machine will incur $4,906 of expenses, and the refurbished machine will incur
$4,677 of expenses. Both machines will have a Return on Investment (ROI) of 9%. How much
Sales will the refurbished machine generate? (Do not round calculations.)
a. $873.27
b. $5,550.27
c. $5,779.27
d. $6,061.60
Ans: B, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This formula requires knowledge of the formula for ROI: Operating Income/Investment. To begin, plug-in the
information provided: 0.09 = (X – $4,677)/$9,703. Now, solve for X: $873.27 = X – $4,677, so X = $5,550.27. The refurbished machine will generate
$5,550.27 of sales (Choice B).

38. Residual Income represents an excess of income that is earned above a firm’s Required Rate of
Return on its investment. Businesses often find that any Residual Income is the preferred
outcome for both managers and the company as a whole. Which of the following correctly
identifies the formula for Residual Income?
a. Operating Income – (Required Rate of Return × Investment)
b. Operating Income – Investment
c. Operating Income + (Required Rate of Return × Investment)
d. Required Rate of Return × Investment
Ans: A, LO 3, Bloom: K, Difficulty: Easy, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with the formula for Residual Income. Choice A is the only choice that correctly identifies the formula:
Operating Income – Target Return or Operating Income – (Required Rate of Return × Investment).

39. Economic Value Added (EVA) is a very well-received metric used to evaluate a company’s
success generating a return that exceeds the cost of capital. Some have claimed that a
business should always strive to focus on and generate EVA. Which of the following correctly
identifies the formula for Economic Value Added?
a. After-tax Operating Income – (Weighted Average Cost of Capital × Invested Capital)
b. After-tax Operating Income + (Weighted Average Cost of Capital/Invested Capital)
c. Pre-tax Operating Income – (Weighted Average Cost of Capital/Invested Capital)
d. Pre-tax Operating Income + (Weighted Average Cost of Capital × Invested Capital)
Ans: A, LO 3, Bloom: K, Difficulty: Easy, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision Analysis.
Solution: This question requires familiarity with the formula for Economic Value Added. Choice A is the only choice that correctly identifies the formula:
After-tax Operating Income – (Weighted Average Cost of Capital × Invested Capital).

40. Jasmine Inc. is a small flower shop that is performing some analysis based on their most recent
year. They have determined that their profit margin was 0.2876 and investment turnover was
 0.2188. They had purchased a new piece of equipment for $3,000. Based upon this information,
what was their Return on Investment (ROI)?
a. 0.0629
b. 0.0688
c. 0.5064
d. 0.7608
Ans: A, LO 3, Bloom: AP, Difficulty: Easy, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for ROI: Profit Margin × Investment Turnover. The cost of
the equipment is not relevant to the answer for this question as it has already been factored into the investment turnover. To solve for ROI, multiply
0.2876 by 0.2188 to arrive at 0.0629 (Choice A).

41. A publishing company is finalizing data for their most recently completed year. The production
department spent $5,000 on a new printer and $3,000 on a new supercomputer. The Operating
Income tied to the new printer is expected to be $556 while the supercomputer is expected to
have an Operating Income of $337. The company’s Required Rate of Return is 6%.
Management would like to know how much Residual Income to expect from the new printer.
a. $219
b. $256
c. $300
d. $556
Ans: B, LO 3, Bloom: AP, Difficulty: Easy, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires the formula for Residual Income and knowledge about how to apply it. The formula is
Operating Income – (Required Rate of Return × Investment). For the printer, do the following: $556 – (0.06 × $5,000) = $556 – $300 = $256 (Choice
B).

42. A publishing company is finalizing data for their most recently completed year. The production
department spent $5,000 on a new printer and $3,000 on a new supercomputer. The Operating
Income tied to the new printer is expected to be $556 while the supercomputer is expected to
have an Operating Income of $337. The company’s Required Rate of Return is 6%.
Management would like to know how much Residual Income to expect from the supercomputer.
a. $157
b. $180
c. $219
d. $337
Ans: A, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires the formula for Residual Income and knowledge about how to apply it. The formula is
Operating Income – (Required Rate of Return × Investment). For the supercomputer, do the following: $337 – (0.06 × $3,000) = $337 – $180 = $157
(Choice A).

43. A small paper producer is considering the purchase of a new machine to add to their assembly
line. This machine would afford them the opportunity to increase their production by 15%. They
are currently gathering pricing information from vendors and are trying to figure out what they
would want to invest. They have gathered the following information:
Expected operating income specifically tied to the new $1,342
machine
Residual Income $ 58
If the company has a Required Rate of Return of 8%, then what amount would they want to
spend on the new machine?
a. $102.72
b. $1,342.00
c. $8,560.00
d. $16,050.00
 Ans: D, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for Residual Income: Operating Income – (Required Rate
of Return × Investment). This question provides some of the numbers. Solve for investment as follows: $58 = $1,342 – (0.08 × Investment). $58 + (0.08
× Investment) = $1,342. (0.08 × Investment) = $1,284. Lastly, divide each side by 0.08. Investment = $16,050.00 (Choice D).

44. A small paper producer is considering the purchase of a new machine to add to their assembly
line. This machine would afford them the opportunity to increase their production by 15%. They
are currently gathering pricing information from vendors and are trying to figure out what they
would want to invest. They have gathered the following information:
Expected operating income specifically tied to the new
machine $1,342
Residual Income $ 58
If the company has a Required Rate of Return of 6.3%, then what is the amount they would
want to spend on the new machine?
a. $84.55
b. $1,400.00
c. $8,560.00
d. $20,380.95
Ans: D, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for Residual Income: Operating Income – (Required Rate
of Return × Investment). This question provides some of these numbers. Solve for investment as follows: $58 = $1,342 – (0.063 × Investment). $58 +
(0.063 × Investment) = $1,342. (0.063 × Investment) = $1,284. Lastly, divide each side by 0.063. Investment = $20,380.95 (Choice D).

45. A bicycle manufacturer is in talks to invest in some new equipment for their production
department, and they are exploring different options. The first option is equipment that will cost
$13,000, have Operating Income of $999, and have Residual Income of $18. The second option
will cost them $11,400, have Operating Income of $918, and have Residual Income of $37. If
the company selects the first option, what is their Required Rate of Return? (Round the
percentage to two decimal places.)
a. 0.14%
b. 7.55%
c. 7.68%
d. 8.61%
Ans: B, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for Residual Income: Operating Income – (Required Rate
of Return × Investment). This question provides some of these numbers. Solve for the Required Rate of Return as follows: $18 = $999 – (Required
Rate of Return × $13,000). $18 + (Required Rate of Return × $13,000) = $999. (Required Rate of Return × $13,000) = $981. Next, divide each side by
$13,000. Required Rate of Return = 0.0755 or 7.55% (Choice B).

46. A bicycle manufacturer is in talks to investment in some new equipment for their production
department, and they are exploring different options. The first option is equipment that will cost
$13,000, have Operating Income of $999, and have Residual Income of $18. The second option
will cost them $11,400, have Operating Income of $918, and have Residual Income of $37. If
the company selects the second option, what is their required rate of return? (Round to the
percentage to two decimal places.)
a. 0.32%
b. 6.78%
c. 7.73%
d. 8.05%
Ans: C, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for Residual Income: Operating Income – (Required Rate
of Return × Investment). This question provides some of these numbers. Solve for the Required Rate of Return as follows: $37 = $918 – (Required
 Rate of Return × $11,400). $37 + (Required Rate of Return × $11,400) = $918. (Required Rate of Return × $11,400) = $881. Next, divide each side by
$11,400. Required Rate of Return = 0.0773 or 7.73% (Choice C).

47. A small surveying company has decided they would like to move their accounting in-house and
will be training a new employee. In anticipation of this new development, they have decided to
purchase a new accounting software package that should service all of their needs. Bob, a
manager, has put together the following information:
Software 1 Software 2
Cost $6,233 $6,899
Residual Income $ 88 $ 104
Required Rate of Return 7.20% 7.20%
If the company selects Software 1, then how much Operating Income should they expect it to
generate?
a. $88.00
b. $442.44
c. $448.78
d. $536.78
Ans: D, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for Residual Income: Operating Income – (Required Rate
of Return × Investment). This question provides some of these numbers. Solve for Operating Income as follows: $88 = Operating Income – (0.072 ×
$6,233). $88 = Operating Income – $448.78. Therefore, Operating Income = $536.78 (Choice D).

48. A small surveying company has decided they would like to move their accounting in-house and
will be training a new employee. In anticipation of this new development, they have decided to
purchase a new accounting software package that should service all of their needs. Bob, a
manager, has put together the following information:

Software 1 Software 2
Cost $6,233 $6,899
Residual Income $ 88 $ 104
Required Rate of Return 7.20% 7.20%
If the company selects Software 2, then how much Operating Income should they expect it to
generate?
a. $104.00
b. $489.24
c. $496.73
d. $600.73
Ans: D, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for Residual Income: Operating Income – (Required Rate
of Return × Investment). This question provides some of these numbers. Solve for Operating Income as follows: $104 = Operating Income – (0.072 ×
$6,899). $104 = Operating Income – $496.73. Operating Income = $600.73 (Choice D).

49. Kit works for a company that creates brochures for travel agencies to distribute to their clients.
The company’s printer has recently broken down and will need to be replaced immediately so
they can meet several upcoming client deadlines. A manager has found a vendor that has a
model available for sale and has compiled the following information and estimates:
Cost of Investment $18,844
Estimates:
Sales $18,965
Operating Expenses $17,303
 If the company has a Required Rate of Return of 8.25%, then what is the amount of Residual
Income that they should anticipate after installing the new printer?
a. $107.37
b. $137.12
c. $1,662.00
d. $17,289.37
Ans: A, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for Residual Income: Operating Income – (Required Rate
of Return × Investment). Operating Income is not given, so solve for it using the following formula: Sales – Operating Expenses = $18,965 – $17,303 =
$1,662. Now, solve for Residual Income. Residual Income = $1,662.00 – (0.0825 × $18,844). Residual Income = $1,662.00 – $1,554.63. Residual
Income = $107.37 (Choice A).

50. Kit works for a company that creates brochures for travel agencies to distribute to their clients.
The company’s printer has recently broken down and will need to be replaced immediately so
that they can meet several client deadlines. A manager has found a vendor that has a model
available for sale and has compiled the following information and estimates:
Cost of Investment $18,844
Estimates:
Sales $18,965
Operating Expenses $17,303

If the company has a Required Rate of Return of 7.75%, then what is the amount of Residual
Income that they should anticipate after installing the new printer?
a. $121.00
b. $201.59
c. $1,460.41
d. $17,504.59
Ans: B, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for Residual Income: Operating Income – (Required Rate
of Return × Investment). Operating Income is not given, so solve for it using the following formula: Sales – Operating Expenses = $18,965 – $17,303 =
$1,662. Now, solve for Residual Income. Residual Income = $1,662.00 – (0.0775 × $18,844). Residual Income = $1,662.00 – $1,460.41. Residual
Income = $201.59 (Choice B).

51. Crosby Inc. creates handmade silk neckties that it then sells on their website through a monthly
subscription service. In an effort to increase membership, Crosby has promised their customers
a one-day turnaround time on all orders. The largest bottleneck Crosby experiences is the
cutting department due to the delicate nature of the material. To improve this process, Crosby
has decided to buy a new cutting machine that would cost $12,400 with a useful life of 5 years.
They estimated that this machine would generate $17,500 of sales and incur $8,788 of asset-
specific expenses (excluding depreciation). If the company has a Required Rate of Return of
9.5%, then what is the Residual Income of this investment?
a. $5,054.00
b. $6,168.00
c. $6,232.00
d. $17,500.00
Ans: A, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for Residual Income: Operating Income – (Required Rate
of Return × Investment). While expenses are given, calculate depreciation to include with the other expenses. $12,400/5 years = $2,480 per year. Total
Expenses will equal $8,788 + $2,480 = $11,268. Operating Income is not given, so solve for it using the following formula: Sales – Operating Expenses
= $17,500 – $11,268 = $6,232. Now, solve for Residual Income. Residual Income = $6,232 – (0.095 × $12,400). Residual Income = $6,232.00 –
$1,178.00. Residual Income = $5,054.00 (Choice A).
52. Crosby Inc. creates handmade silk neckties that it then sells on their website through a monthly
subscription service. In an effort to increase membership, Crosby has promised their customers
a one-day turnaround time on all orders. The largest bottleneck Crosby experiences is the
cutting department due to the delicate nature of the material. To improve this process, Crosby
has decided to buy a new cutting machine that would cost $12,400 with a useful life of 5 years.
They estimated that this machine would generate $17,500 of sales and incur $8,788 of asset-
specific expenses (excluding depreciation). If the company has a Required Rate of Return of
7.3%, then what is their Residual Income?
a. $5,100.00
b. $5,326.80
c. $6,232.00
d. $17,500.00
Ans: B, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for Residual Income: Operating Income – (Required Rate
of Return × Investment). While expenses are given, calculate depreciation to include with the other expenses. $12,400/5 years = $2,480 per year. Total
expenses will equal $8,788 + $2,480 = $11,268. Operating Income is not given, so solve for it using the following formula: Sales – Operating Expenses
= $17,500 – $11,268 = $6,232. Now, solve for Residual Income. Residual Income = $6,232 – (0.073 × $12,400). Residual Income = $6,232.00 –
$905.20. Residual Income = $5,326.80 (Choice B).

53. Esther is the manager of the sales department for a local appliance store. The employees have
been voicing their concerns over the current Point-of-Sale (POS) system they use for various
aspects of their job. A new machine would afford them the opportunity to better service
customers, including real-time pricing and an on-the-spot checkout process. The new POS
system would cost $31,828 and would generate $7,442 of Operating Income. The company has
a Required Rate of Return of 8% and their tax rate is 23%. If the Weighted Average Cost of
Capital (WACC) is 6.7%, then what would their Economic Value Added (EVA) be? (Do not
round intermediate calculations.)
a. $3,184.10
b. $3,597.86
c. $4,895.76
d. $5,309.52
Ans: B, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for EVA: After-tax Operating Income – (WACC × Invested
Capital). This question includes a required rate of return, but that information is not needed for this question. EVA = ($7,442.00 × (1 – 0.23)) – (0.067 ×
$31,828.00) = $5,730.34 – $2,132.48 = $3,597.86 (Choice B).

54. Esther is the manager of the sales department for a local appliance store. The employees have
been voicing their concerns over the current Point-of-Sale (POS) system they use for various
aspects of their job. A new machine would afford them the opportunity to better service
customers, including real-time pricing and an on-the-spot checkout process. The new POS
system would cost $31,828 and would generate $7,442 of Operating Income. The company has
a Required Rate of Return of 8% and their tax rate is 23%. If the Weighted Average Cost of
Capital (WACC) is 7.7%, then what would their Economic Value Added (EVA) be?
a. $3,184.10
b. $3,279.58
c. $4,895.76
d. $4,991.24
Ans: B, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for EVA: After-tax Operating Income – (WACC × Invested
Capital). This question includes a required rate of return, but that information is not needed for this question. EVA = ($7,442.00 × (1 – 0.23)) – (0.077 ×
$31,828.00) = $5,730.34 – $2,450.76 = $3,279.58 (Choice B).
55. A company is debating replacing the GPS system in a company vehicle that is used every day
of the work week. By replacing the current older model GPS system in the vehicle, the company
anticipates being able to add an additional $1,324 of Operating Income this year that will
ultimately result in an Economic Value Added (EVA) of $806.43. If the company has a tax rate of
24% and a Weighted Average Cost of Capital (WACC) of 6%, then what is the cost of the new
investment?
a. $60.37
b. $1,812.67
c. $3,330.17
d. $13,440.50
Ans: C, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for EVA: After-tax Operating Income – (WACC × Invested
Capital). In this case, solve for investment using the other variables provided. $806.43 = ($1,324 × (1 – 0.24)) – (0.06 × Investment). $806.43 =
$1,006.24 – (0.06 × Investment). (0.06 × Investment) = $199.81. Lastly, divide each side by 0.06. Investment = $3,330.17 (Choice C).

56. A company is debating replacing the GPS system in a company vehicle that is used every day
of the work week. By replacing the current older model GPS system in the vehicle, the company
anticipates being able to add an additional $1,324 of Operating Income this year that will
ultimately result in an Economic Value Added (EVA) of $806.43. If the company has a tax rate of
22% and a Weighted Average Cost of Capital (WACC) of 7.5%, then what is the cost of the new
investment?
a. $2,130.43
b. $3,017.20
c. $10,752.40
d. $13,769.60
Ans: B, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for EVA: After-tax Operating Income – (WACC × Invested
Capital). In this case, solve for investment using the other variables provided. $806.43 = ($1,324 × (1 – 0.22)) – (0.075 × Investment). $806.43 =
$1,032.72 – (0.075 × Investment). (0.075 × Investment) = $226.29. Lastly, divide each side by 0.075. Investment = $3,017.20 (Choice B).

57. Brown Bag, Inc. is a company that manufactures colorful lunch bags made from compostable
paper. Management would like to increase production and knows the only way to do this would
be to add an additional industrial cutting machine. Brown Bag has a Required Rate of Return of
8.2%, a Weighted Average Cost of Capital (WACC) of 6.3%, and a tax rate of 25%. The cutting
machine will cost $22,407 and has a useful life of 15 years. How much Operating Income
(before tax) must be generated to achieve an Economic Value Added (EVA) of $1,356.00? (Do
not round intermediate calculations.)
a. $55.64
b. $2,767.64
c. $3,690.19
d. $4,257.83
Ans: C, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for EVA: After-tax Operating Income – (WACC × Invested
Capital). In this case, solve for Operating Income using the other variables provided. $1,356.00 = (Operating Income × (1 – 0.25)) – (0.063 ×
$22,407.00). $1,356.00 = (Operating Income × 0.75) – $1,411.64. $2,767.64 = (Operating Income × 0.75). Lastly, divide each side by 0.75. Operating
Income = $3,690.19 (Choice C).

58. Brown Bag, Inc. is a company that manufactures colorful lunch bags made from compostable
paper. Management would like to increase production and knows the only way to do this would
be to add an additional industrial cutting machine. Brown Bag has a required rate of return of
8.2%, a Weighted Average Cost of Capital (WACC) of 6.3%, and a tax rate of 25%. The cutting
machine will cost $22,407 and has a useful life of 15 years. How much Operating Income
 (before tax) must be generated to achieve an Economic Value Added (EVA) of $551.43? (Do
not round intermediate calculations.)
a. $1,882.19
b. $1,963.07
c. $2,617.43
d. $3,185.07
Ans: C, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for EVA: After-Tax Operating Income – (WACC × Invested
Capital). In this case, solve for Operating Income using the other variables provided. $551.43 = (Operating Income × (1 – 0.25)) – (0.063 ×
$22,407.00). $551.43 = (Operating Income × 0.75) – $1,411.64. $1,963.07 = Operating Income × 0.75. Lastly, divide each side by 0.75. Operating
Income = $2,617.43 (Choice C).

59. Cordelia is a machine operator for Forever Twenty-Five and specifically works on handbags.
Forever Twenty-Five would like to begin offering tie-dyed backpacks. In addition to a new
product, Forever Twenty-Five will also need to purchase a piece of equipment that is able to
stretch and then tie-dye the fabric for the backpack. Cordelia has priced out two different
machines. The first will cost $5,674, generate $1,560 of sales, and will incur $992 of operating
expenses. The second will cost $6,782, generate $1,733 of sales, and will incur $1,020 of
operating expenses. The company has Weighted Average Cost of Capital (WACC) of 6.1% and
a Required Rate of Return of 7.2%. Forever Twenty-Five has a current tax rate of 22%. What
will the Economic Value Added (EVA) be for the first machine? (Do not round intermediate
calculations.)
a. $96.93
b. $346.11
c. $443.04
d. $568.00
Ans: A, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for EVA: After-tax Operating Income – (WACC × Invested
Capital). This question includes a required rate of return, but that information is not needed for this solution. Before solving for EVA, solve for Operating
Income by subtracting operating expenses from sales: $1,560 – $992 = $568.00. EVA = ($568.00 × (1 – 0.22)) – (0.061 × $5,674.00). EVA = $443.04 –
$346.11 = $96.93 (Choice A).

60. Cordelia is a machine operator for Forever Twenty-Five and specifically works on handbags.
Forever Twenty-Five would like to begin offering tie-dyed backpacks. In addition to a new
product, Forever Twenty-Five will also need to purchase a piece of equipment that is able to
stretch and then tie-dye the fabric for the backpack. Cordelia has priced out two different
machines. The first will cost $5,674, generate $1,560 of sales, and will incur $992 of operating
expenses. The second will cost $6,782, generate $1,733 of sales, and will incur $1,020 of
operating expenses. The company has Weighted Average Cost of Capital (WACC) of 6.1% and
a Required Rate of Return of 7.2%. Forever Twenty-Five has a current tax rate of 22%. What
will the Economic Value Added (EVA) be for the second machine? (Do not round intermediate
calculations.)
a. $96.93
b. $142.44
c. $299.30
d. $413.70
Ans: B, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for EVA: After-tax Operating Income – (WACC × Invested
Capital). This question includes a required rate of return, but that information is not needed for this solution. Before solving for EVA, solve for Operating
Income by subtracting operating expenses from sales: $1,733 – $1,020 = $713.00. EVA = ($713.00 × (1 – 0.22)) – (0.061 × $6,782.00). EVA = $556.14
– $413.70 = $142.44 (Choice B).

61. A company has gathered the following information about a potential fixed asset purchase:
 Cost of asset $15,000
10
Useful life years
Operating Income (Net of all expenses except
depreciation) $4,677
Company’s required rate of return 8.2%

If the company has a 20% tax rate and their Economic Value Added (EVA) is $112.00, then
what is their Weighted Average Cost of Capital (WACC)?
a. 8.2%
b. 16.20%
c. 16.94%
d. 21.18%
Ans: B, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for EVA: After-tax Operating Income – (WACC × Invested
Capital). Before solving for EVA, solve for the Operating Income after depreciation by subtracting depreciation. $15,000/10 years = $1,500 in
depreciation expenses per year. Operating Income = $4,677 – $1,500 = $3,177. $112.00 = ($3,177.00 × (1 – 0.20)) – (WACC × $15,000.00). $112.00 =
$2,541.60 – (WACC × $15,000.00). (WACC × $15,000.00) = $2,541.60 – $112.00. WACC × $15,000.00 = $2,429.60. Now, divide each side by
$15,000 to solve for WACC. WACC = 16.20% (Choice B).

62. A company has gathered the following information about a potential fixed asset purchase:
Cost of asset $15,000
10
Useful life years
Operating Income (Net of all expenses except
depreciation) $4,677
Company’s required rate of return 8.2%

If the company has a 24% tax rate and their Economic Value Added (EVA) is $246.00, then
what is their Weighted Average Cost of Capital (WACC)?
a. 14.46%
b. 16.10%
c. 17.74%
d. 21.28%
Ans: A, LO 3, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for EVA: After-tax Operating Income – (WACC × Invested
Capital). Before solving for EVA, solve for the Operating Income after depreciation by subtracting depreciation. $15,000/10 years = $1,500 in
depreciation expenses per year. Operating Income = $4,677 – $1,500 = $3,177. $246.00 = ($3,177.00 × (1 – 0.24)) – (WACC × $15,000.00). $246.00 =
$2,414.52 – (WACC × $15,000.00). (WACC × $15,000.00) = $2,414.52 – $246.00. WACC × $15,000.00 = $2,168.52. Now, divide each side by
$15,000 to solve for WACC. WACC = 14.46% (Choice A).

63. Oscar is the manager of the component division for a small manufacturing company, and his
department is evaluated using various metrics each year including their Return on Investment
(ROI). Oscar is debating whether he should purchase a new machine for his department. Oscar
is determined to have an ROI of at least 7%. He is considering the purchase of Machine A with
a return on sales of 0.3877, sales of $2,349, and a 10-year useful life or Machine B with a return
on sales of 0.3994, sales of $2,560, and a 9-year useful life. Each machine would be
depreciated using straight-line method. What is the yearly Depreciation Expense for Machine A?
(Do not round intermediate calculations.)
a. $1,301.01
b. $1,310.64
c. $1,417.50
 d. $1,445.18
Ans: A, LO 1, 3, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires the use of multiple steps in order to calculate the amount of yearly depreciation. The
first step is to use the formula for ROI to determine the cost of the investment for Machine A. ROI = Return on Sales × Investment Turnover. 0.07 =
0.3877 × Investment Turnover. Investment Turnover = 0.1806. Now, use the formula for Investment Turnover to calculate the cost of the investment.
Investment Turnover = Sales/Investment. 0.1806 = $2,349/Investment. Investment × 0.1806 = $2,349. Investment = $13,010.10. Lastly, divide this total
by the machine’s useful life to calculate its yearly depreciation. $13,010.10/10 years = $1,301.01 (Choice A).

64. Oscar is the manager of the component division for a small manufacturing company, and his
department is evaluated using various metrics each year including Return on Investment (ROI).
Oscar is debating whether he should purchase a new machine for his department. Oscar is
determined to have an ROI of at least 7%. He is considering the purchase of Machine A with a
return on sales of 0.3877, sales of $2,349, and a 10-year useful life or Machine B with a return
on sales of 0.3994, sales of $2,560, and a 9-year useful life. Each machine would be
depreciated using straight-line machine. What is the yearly Depreciation Expense for Machine
B? (Do not round intermediate calculations.)
a. $1,339.99
b. $1,460.35
c. $1,488.88
d. $1,622.96
Ans: D, LO 1, 3, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires the use of multiple steps in order to calculate the amount of yearly depreciation. The
first step is to use the formula for ROI to determine the cost of the investment for Machine B. ROI = Return on Sales × Investment Turnover. 0.07 =
0.3994 × Investment Turnover. Investment Turnover = 0.1753. Now, use the formula for Investment Turnover to calculate the cost of the investment.
Investment Turnover = Sales/Investment. 0.1753 = $2,560/Investment. Investment × 0.1753 = $2,560. Investment = $14,606.63. Lastly, divide this total
by the machine’s useful life to calculate its yearly depreciation. $14,606.63/9 years = $1,622.96 (Choice D).

65. Smith Industries is in desperate need of a new press machine for their production department.
The manager has been asked to select the most favorable option while keeping in mind that any
decision made may also impact their department’s evaluation. Given this, the manager knows
that performing a thorough analysis is crucial. A machine could be purchased from Grove Inc.
for a total cost of $9,677 and would generate Operating Income of $3,705. A different machine
could be purchased from Forest Inc. for a total cost of $9,003 and would generate Operating
Income of $3,432. The company has provided the following information:
Required Rate of Return 8.12%
Cost of Debt 6.5%
Cost of Equity 8.3%
Proportion of Debt 65%
Proportion of Equity 35%
Economic Value Added
(EVA) $2,558

What is the tax rate for the press machine from Grove? Assume the company uses an effective
tax rate that is rounded to the four places. (Do not round intermediate calculations.)
a. 12.34%
b. 14.66%
c. 17.84%
d. 18.62%
Ans: A, LO 1, 3, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: In order to solve for the tax rate, the formula for EVA must be used, but first, solve for the Weighted Average
Cost of Capital (WACC). WACC = (Cost of Debt × Proportion of Capital Financed with Debt) + (Cost of Equity × Proportion of Capital Financed with
Equity). WACC = (0.065 × 0.65) + (0.083 × 0.35) = 0.04225 + 0.02905 = 0.0713. Now, the EVA formula can be used to calculate the tax rate. EVA =
After-Tax Operating Income – (WACC × Investment). $2,558 = ($3,705 × (1 – Tax Rate)) – (0.0713 × $9,677). $2,558 = ($3,705 × (1 – Tax Rate)) –
$689.97. $3,247.97 = $3,705 × (1 – Tax Rate). So, the tax rate to four places is 0.1234. As a percentage, the tax rate is therefore 12.34% (Choice A).
66. Smith Industries is in desperate need of a new press machine for their production department.
The manager has been asked to select the most favorable option while keeping in mind that any
decision made may also impact their department’s evaluation. Given this, the manager knows
that performing a thorough analysis is crucial. A machine could be purchased from Grove Inc.
for a total cost of $9,677 and would generate Operating Income of $3,705. A different machine
could be purchased from Forest Inc. for a total cost of $9,003 and would generate Operating
Income of $3,432. The company has provided the following information:
Required Rate of Return 8.12%
Cost of Debt 6.5%
Cost of Equity 8.3%
Proportion of Debt 65%
Proportion of Equity 35%
Tax rate 22%

What is the percentage difference in EVA for the press machine from Grove when compared to
the press machine from Forest? (Do not round intermediate calculations.)
a. The EVA of the press machine from Forest is 7.49% higher than the EVA of the
press machine from Grove.
b. The EVA of the press machine from Forest is 8.1% higher than the EVA of the press
machine from Grove.
c. The EVA of the press machine from Grove is 7.49% higher than the EVA of the
press machine from Forest.
d. The EVA of the press machine from Grove is 8.1% higher than the EVA of the press
machine from Forest.
Ans: D, LO 1, 3, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: In order to solve for the tax rate, the formula for EVA will eventually be used, but first, solve for the Weighted
Average Cost of Capital (WACC). WACC = (Cost of Debt × Proportion of Capital Financed with Debt) + (Cost of Equity × Proportion of Capital
Financed with Equity). WACC = (0.065 × 0.65) + (0.083 × 0.35) = 0.04225 + 0.02905 = 0.0713. Now, the EVA formula can be used to calculate the tax
rate. EVA = After-Tax Operating Income – (WACC × Investment).
Grove Press Machine: EVA = ($3,705 × (1 – 0.22)) – (0.0713 × $9,677). EVA = $2,889.90 - $689.97. EVA = $2,199.93.
Forest Press Machine: EVA = ($3,432 × (1 – 0.22)) – (0.0713 × $9,003). EVA = $2,676.96 - $641.91. EVA = $2,035.05.
To calculate the percentage difference, use horizontal analysis. (Grove Machine EVA – Forest Machine EVA)/(Forest Machine EVA) = ($2,199.93 –
$2,035.05)/$2,035.05 = $164.88/$2,035.05 = 0.0810. The Grove Press Machine has an EVA that is 8.1% higher than the Forest Press Machine
(Choice D).

67. Landry Corp. is evaluating one of its recent investments and the financial aspects of their
investment. The Investment Center has provided the following data:

Invested Capital $13,422

$2
Expected Annual Sales 9,870
Expected Annual $2
Expenses 7,606
Tax Rate 23%
Required Rate of Return 8.6%
Economic Value Added
(EVA) $33.90
Proportion of Debt 72%
Cost of Debt ?
Proportion of Equity 28%
 Cost of Equity 9%

Based on the information provided above, what is the company’s Cost of Debt? (Do not round
intermediate calculations.)
a. 10.22%
b. 12.74%
c. 14.19%
d. 24.20%
Ans: C, LO 2, 3, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question involves multiple steps before arriving at the Cost of Debt. The first step is to use the formula
for Economic Value Added (EVA) to determine the Weighted Average Cost of Capital (WACC). EVA = After-Tax Operating Income – (WACC ×
Investment). $33.90 = (($29,870 – $27,606) × (1 – 0.23)) – (WACC × $13,422). $33.90 = ($2,264 × 0.77) – (WACC × $13,422). $33.90 = $1,743.28 –
(WACC × $13,422). –$1,709.38 = –WACC × $13,422. Next, divide each side by $13,422. –0.1274 = –WACC. Then, divide each side by –1 to find the
WACC. WACC = 0.1274. Now, use the formula for WACC to calculate the Cost of Debt. WACC = (Cost of Debt × Proportion of Capital Financed with
Debt) + (Cost of Equity × Proportion of Capital Financed with Equity). 0.1274 = (Cost of Debt × 0.72) + (0.09 × 0.28). 0.1274 = (Cost of Debt × 0.72) +
0.0252. 0.1022 = Cost of Debt × 0.72. Finally, divide each side by 0.72 to find the Cost of Debt. So, Cost of Debt = 0.1419 or 14.19% (Choice C).

68. Landry Corp. is evaluating one of its recent investments and the financial aspects of their
investment. The Investment Center has gathered the following data:

Invested Capital $13,422

$2
Expected Annual Sales 9,870
Expected Annual $2
Expenses 7,606
Tax Rate 23%
Required Rate of Return 8.6%
Economic Value Added
(EVA) $33.90
Proportion of Debt 72%
Cost of Debt 6.4%
Proportion of Equity 28%
Cost of Equity ?

Based on the information provided above, what is the company’s Cost of Equity? (Do not round
intermediate calculations.)
a. 8.13%
b. 12.74%
c. 17.35%
d. 29.03%
Ans: D, LO 2, 3, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question involves multiple steps before arriving at the Cost of Debt. The first step will be to use the
formula for Economic Value Added (EVA) to determine the Weighted Average Cost of Capital (WACC). EVA = After-tax Operating Income – (WACC ×
Investment). $33.90 = (($29,870 – $27,606) × (1 – 0.23)) – (WACC × $13,422). $33.90 = ($2,264 × 0.77) – (WACC × $13,422). $33.90 = $1,743.28 –
WACC × $13,422. –$1,709.38 = –WACC × $13,422. Next, divide each side by $13,422. –0.1274 = –WACC. Then, divide each side by –1 to find the
WACC. WACC = 0.1274. Now, use the formula for WACC to calculate the Cost of Equity. WACC = (Cost of Debt × Proportion of Capital Financed with
Debt) + (Cost of Equity × Proportion of Capital Financed with Equity). 0.1274 = (0.064 × 0.72) + (Cost of Equity × 0.28). 0.1274 = 0.0461 + (Cost of
Equity × 0.28). 0.0813 = Cost of Equity × 0.28. Lastly, divide each side by 0.28 to find the Cost of Equity. So, Cost of Equity = 0.2903 or 29.03%
(Choice D).

69. All business units are created with certain goals against which they are measured. Regardless of
the type of business unit, evaluations are utilized to ensure that management is directing the team
towards the achievement of goals that are congruent with the overall company goals set forth by
 the highest levels of management. Which of the following best represent metrics used to evaluate
an investment center?
a. Profit Margin, Investment Turnover, Year-to-Date Expenditures
b. Residual Income, Sales Order per Customer, Profit Margin
c. Return on Investment, Residual Income, Investment Turnover
d. Return on Investment, Target Profit, Economic Value Added
Ans: C, LO 2, 3, Bloom: K, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with the evaluation of various responsibility centers. Choice C is the only choice of the four options
that represent metrics that would be used to evaluate an investment center. The other choices are a mixture of metrics used to evaluate an investment
center or other types of responsibility centers.

70. The crinkle-cut division of a French fry company had the following results last year with all
production sold to outside customers:
Sales (25,000 pounds of $10,000
fries)
Variable Expenses 4,000
Contribution Margin $ 6,000
Fixed Expenses 3,500
Operating Income $ 2,500

The crinkle-cut division has a 30,000 pound of processing capacity. If the crinkle-cut division
were to transfer the remaining capacity to an internal division or unit, what would the minimum
acceptable transfer price be?
a. $0.13
b. $0.14
c. $0.16
d. $0.40
Ans: C, LO 4, Bloom: AP, Difficulty: Easy, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with how transfer pricing is calculated when a company has excess
capacity. In the given scenario, the minimum acceptable transfer price would be variable cost per unit, which is Variable Expenses/Number of Units
Produced = $4,000/25,000 = $0.16 per pound (Choice C).

71. The crinkle-cut division for a French fry company had the following results last year with all
production sold to outside customers:
Sales (25,000 pounds of $10,000
fries)
Variable Expenses 4,000
Contribution Margin $ 6,000
Fixed Expenses 3,500
Operating Income $ 2,500

The crinkle-cut division has a 30,000-pound processing capacity. If the crinkle-cut division were
to transfer the remaining capacity to an internal division or unit, what would the minimum
additional amount of profit be?
a. $0
b. $800
c. $4,000
d. $4,800
Ans: A, LO 4, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with how transfer pricing is calculated when a company has excess
 capacity and the additional profit this would create. To determine the minimum acceptable transfer price, calculate the variable cost per unit: Variable
Expenses/Number of Units Produced = $4,000/25,000 = $0.16 per pound. Selling 5,000 pounds at $0.16 would bring additional sales of 5,000 × $.016
= $800 and variable costs of $800. The question asked how much profit would be generated, and the answer is $0 as the variable costs cancel out the
additional sales (Choice A).

72. A marble factory has two divisions: Kiln Division and Painting Division. The Kiln Division had
Sales of $33,000 and Variable Costs of $25,000 while the Painting Division had Sales of
$30,000 and Variable Costs of $21,000. Production and sales for each division are 66,000
pounds. The Kiln Division sells its all-unpainted marble to the Painting Division and does not sell
to anyone else. What is the current transfer price?
a. $0.12 per pound
b. $0.14 per pound
c. $0.45 per pound
d. $0.50 per pound
Ans: D, LO 4, Bloom: AP, Difficulty: Easy, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the way that transfer pricing is calculated by dividing sales by the
number of units sold. For this question, focus on the numbers attributable to the Kiln Division since it is they who will be transferring the materials rather
than selling them to an outside market. Current transfer price = $33,000/66,000 = $0.50 per pound (Choice D).

73. A jewelry company has several business units, including their Silver Processing unit and their
Earrings unit. The Silver Processing unit typically sells all of its silver to external companies
unless an internal division or business unit decides to use them as their supplier. The Earrings
unit has decided to add a line of silver hoops to the line of gold hoops they have been selling for
several years. Prior to this request, the Silver Processing unit reported the following numbers for
the year:

Sales (14,400 ounces of silver) $318,528

Variable expenses 182,448
Contribution margin $136,080
Fixed expenses 84,320
Operating Income $ 51,760

The Silver Processing unit has a capacity of 15,000 ounces of silver, and the Earrings unit has
expressed an interest in purchasing the remaining ounces in Silver’s processing capacity. What
is the minimum acceptable transfer price on the ounces of silver if the Earrings division
purchases them?
a. $3.59 per ounce
b. $9.45 per ounce
c. $12.67 per ounce
d. $22.12 per ounce
Ans: C, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires determination of the minimum acceptable transfer price if this sale takes the Silver
Processing unit to capacity without surpassing that. In the given scenario, the minimum acceptable transfer price would be equal to the variable cost
per unit. This is calculated by dividing the total variable expenses by the ounces of silver processed. $182,448/14,400 ounces = $12.67 per ounce.
Since they are not exceeding capacity, there would not be a need to add any other costs (Choice C).

74. A jewelry company has several business units, including their Silver Processing unit and their
Earrings unit. The Silver Processing unit typically sells all of its silver to external companies
unless an internal division or business unit decides to use them as their supplier. The Earrings
unit has decided to add a line of silver hoops to the line of gold hoops they have been selling for
several years. Prior to this request, the Silver Processing unit reported the following numbers for
the year:
 Sales (14,400 ounces of silver) $318,528
Variable expenses 182,448
Contribution margin $136,080
Fixed expenses 84,320
Operating Income $ 51,760

The Silver Processing unit has a capacity of 15,000 ounces of silver, and the Earrings unit has
expressed an interest in purchasing 1,000 ounces from the Silver Processing unit. What is the
total revenue generated on the ounces of silver sold to the Earrings unit?
a. $8,848.00
b. $12,670.00
c. $16,450.00
d. $22,120.00
Ans: C, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires determination of the minimum acceptable transfer price if this sale takes the Silver
Processing unit to capacity and surpasses it. That means there will be two acceptable prices. In order to calculate the minimum acceptable transfer
price for the 600 (15,000 – 14,400) ounces in capacity, that would be equal to the variable cost per unit for those 600 ounces. This is calculated by
dividing the variable expenses by the ounces of silver processed. $182,448/14,400 ounces = $12.67 per ounce. The remaining units in this order (if
any), would have a minimum acceptable transfer price of the variable cost per unit plus the contribution margin per unit for the units that surpass the
unit’s capacity. This number would equal the market price per unit for those units. $12.67 + ($136,080/14,400 ounces) = $12.67 + $9.45 = $22.12 per
ounce. The number of units at this price will be 1,000 – 600 = 400 ounces of silver. The total revenue will be (600 × $12.67) + (400 × $22.12) =
$16,450.00 (Choice C).

75. Sally is compiling some numbers for the factory where she works. This factory has many
business units, and some sell to external customers only, some sell internally only, and some
sell to both internal and external customers. She is specifically looking at Business Unit A which
sells primarily to external customers but will also sell to other internal business units. Business
Unit A currently has no idle capacity, $2.97 per unit of opportunity cost, and $189,650 in fixed
costs. Determine the overall variable cost if business unit A had sales of 75,000 units for a total
of $322,500.
a. $33,100
b. $99,750
c. $222,750
d. $322,500
Ans: B, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for the minimum acceptable transfer price when there is no
idle capacity: variable cost per unit + opportunity cost per unit. And, the minimum acceptable transfer price in this case will be equal to the sales price
per unit to external customers = $322,500/75,000 units = $4.30 per unit. Now, substitute these numbers into the formula after rearranging it: $4.30
(minimum acceptable transfer price) – $2.97 (opportunity cost per unit) = $1.33 (variable cost per unit). Lastly, multiply the variable cost per unit by the
number of units sold externally: $1.33 × 75,000 = $99,750 (Choice B).

76. Sally is compiling some numbers for the factory where she works. This factory has many
business units, some sell to external customers only, some sell internally only, and some sell to
both internal and external customers. She is specifically looking at Business Unit A which sells
primarily to external customers but will also sell to other internal business units within the
company. Business Unit A currently has no idle capacity, $2.97 per unit of opportunity cost, and
$189,650 in fixed costs. Business Unit A had sales of 75,000 units for a total of $322,500. If an
internal department wants to purchase 4,370 units, then what would Business Unit A’s additional
profit be?
a. $0.00
b. $5,812.10
c. $12,978.90
d. $18,791.00
 Ans: A, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with the formula for the minimum acceptable transfer price when there is no
idle capacity: variable cost per unit + opportunity cost per unit. The minimum acceptable transfer price in this case would be equal to the sales price per
unit to external customers = $322,500/75,000 units = $4.30. The internal amount of the sale would be: 4,370 units × $4.30 = $18,791. Since the units
are being sold to the internal entity for the same amount as they would be sold to an external party, the sale would result in additional profit of $0.00
(Choice A).

77. The Happy Coffee Company manufactures coffee mugs and sells them to external vendors.
They have several divisions that are involved in the process and sell to one another internally.
The very last department involved in this process is the Distribution department who sells the
final product to local coffee shops. The Distribution department purchases all their units
internally from the Glazing department. The sales from the Distribution department to the
external vendors amounted to 19,412 mugs for a total of $181,725.72. If the Operating Incomes
per unit were as follows for each division: Distribution, $4.56; and Glazing, $1.90; then what is
the Cost of Goods Sold (COGS) for the Glazing department? (Do not round your calculations.)
a. $56,324.20
b. $88,518.72
c. $93,177.60
d. $181,725.72
Ans: A, LO 4, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires understanding of how the overall Operating Income is calculated when total sales
involve internal sales as well as sales of the end product to an external entity. If the sales value is divided by the number of mugs sold, then the per-unit
selling price can be calculated: $181,725.72/19,412 = $9.36 per unit. Next, use the Operating Income formula to determine the COGS: Sales – COGS
(cost to acquire from Glazing) = Operating Income, so $9.36 – COGS = $4.56, and COGS = $4.80 per unit. Now, calculate the COGS for the Glazing
department by applying this same formula: Sales – COGS = Operating Income, so $4.80 – COGS = $1.90. COGS = $2.90 per coffee mug. Lastly, to
calculate the total COGS, multiply this value by the number of mugs sold: $2.90 × 19,412 mugs = $56,324.20 (Choice A).

78. The Happy Coffee Company manufactures coffee mugs in-house that it then sells to external
vendors. They have several divisions that are involved in the process and sell to one another
internally. The very last department involved in this process is the Distribution department who
sells the final product to local coffee shops. The Distribution department purchases all of their
units internally from the Glazing department. The sales from the Distribution department to the
external vendors amounted to 19,412 mugs for a total of $181,725.72. If the Operating Incomes
per unit were as follows for each division: Distribution, $4.56; and Glazing, $1.90; then what is
the Cost of Goods Sold (COGS) per unit for the Glazing department?
a. $1.90
b. $2.90
c. $4.56
d. $4.80
Ans: B, LO 4, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires understanding of how the overall Operating Income is calculated when sales involve
internal sales as well as sales of the end product to an external entity. If the sales value is divided by the number of mugs sold, then the per-unit selling
price can be calculated: $181,725.72/19,412 = $9.36 per unit. Sales – COGS (cost to acquire from glazing) = Operating Income, so $9.36 – COGS =
$4.56, and COGS = $4.80 per unit. Lastly, calculate the COGS for the Glazing department by applying this same formula: Sales – COGS = Operating
Income. $4.80 – COGS = $1.90. COGS = $2.90 per coffee mug (Choice B).

79. Most companies begin with a centralized organizational model and gradually move towards a
decentralized model. As some companies grow, they acquire other companies in an effort to
streamline operations and become more efficient. One result of these acquisitions is integration.
Which of the following is an example of vertical integration?
a. A company that manufactures coffee makers acquires their largest competitor in the
market, making them the largest coffee maker manufacturers in the United States.
b. A company that manufactures handbags acquires a company that manufactures
wallets so that they can expand their customer offerings.
 c. A factory that manufactures furniture purchases a furniture marketing and distribution
firm.
d. A factory that produces tortilla chips acquires a company that produces salsa so they
can begin to offer deals on both products when purchased at the same time.
Ans: C, LO 4, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with integration, specifically vertical integration. This type of integration involves a company
acquiring another company that exists within the same value chain. Choice C is the only choice listed that accurately depicts a situation where a
company is buying another company within the same value chain. The other choices are forms of mergers and acquisitions but not vertical integration.

80. Most companies begin with a centralized organizational model and gradually move towards a
decentralized model. As some companies grow, they will acquire others in an effort to
streamline operations and become more efficient. One result of these acquisitions is integration.
Which of the following is an example of an integration type other than vertical integration?
a. A factory that produces paint acquires a factory that produces dyes.
b. A frozen pizza manufacturer acquires a factory that produces pizza sauce.
c. A peanut butter producer buys a factory that manufactures jelly.
d. An automobile manufacturer purchases a factory that produces tires.
Ans: C, LO 4, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with integration, specifically vertical. A vertical type of integration involves a company acquiring
another company that exists within the same value chain. Choice C is the only choice listed that accurately depicts a situation where a company is
buying another company that is not within the same value chain, resulting in a different kind of merger. The other choices are examples of vertical
integration.

81. As companies expand and become more decentralized, they will often seek ways in which they
can save money. Additionally, management will seek ways to increase efficiency, and that may
include purchasing other companies. These acquisitions will involve an integration of the supply
chain and will help the company better achieve long-term company goals. Which of the following
is an example of backward vertical integration?
a. A customer service company purchases their largest competitor, creating a market-
dominating entity.
b. A factory that produces handbags has purchased a company with a fleet of trucks so
they can deliver their own goods.
c. A hot dog producer purchases a company that creates hot dog buns.
d. A toy company that designs all products in-house has acquired a company with a
strong research and development department to assist in testing new products.
Ans: D, LO 4, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with integration, specifically backward vertical. This type of integration involves a company
acquiring another company that exists within the same value chain. Choice D is the only choice listed that accurately depicts a situation where a
company is buying another company within the same value chain that is also backward vertical as it is moving upstream. The other choices are forms
of integrations but not necessarily backward vertical.

82. As companies expand and become more decentralized, they will often seek ways in which they
can save money. Additionally, management will seek ways to increase efficiency, and that may
include purchasing other companies. These acquisitions will involve an integration of the supply
chain and will help the company better achieve long-term company goals. Which of the following
is an example of an integration type other than backward vertical?
a. A busy carrier freight company buys a company that produces cardboard boxes to
take advantage of internal transfer pricing.
b. A factory that produces handbags has purchased a company with a strong research
and development department.
c. A farm that grows soybeans purchases a company that can convert the beans into
soy milk that will be available for resale.
 d. An auto mechanic at a small garage purchases the parts supply store next door to
have quicker access to what they need to work efficiently.
Ans: C, LO 4, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with integration, specifically backward vertical. This type of integration involves a company
acquiring another company that exists within the same value chain. Choice C is the only choice listed that accurately depicts a situation where a
company is buying another company within the same value chain that is an integration other than backward vertical. The other choices are forms of
backward vertical integrations.

83. After a company has decided to vertically integrate with another, they will have to seriously
consider whether to move upstream or downstream within their value chain. Each direction has
its advantages and disadvantages and plays a crucial role in the improved efficiency post-
acquisition. Which of the following is an example of forward vertical integration?
a. A local café purchases a small local coffee roaster to source their coffee beans
locally.
b. A telecommunications company that manufactures cell phones acquires a marketing
company to move the marketing process in-house.
c. A telecommunications company that manufactures cell phones acquires a product
design firm to move the product design process in-house.
d. An auto mechanic at a small garage purchases the parts supply store next door to
have quicker access to what they need to work efficiently.
Ans: B, LO 4, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with integration, specifically forward vertical. This type of integration involves a company acquiring
another company that exists within the same value chain. Choice B is the only choice listed that accurately depicts a situation where a company is
buying another company within the same value chain that is also forward vertical as it is moving downstream. The other choices are forms of
integrations but not necessarily forward vertical.

84. After a company has decided to vertically integrate with another, they will have to seriously
consider whether to move upstream or downstream within their value chain. Each direction has
its advantages and disadvantages and plays a crucial role in the improved efficiency post-
acquisition. Which of the following is an example of an integration type other than forward
vertical?
a. A carrier freight company buys a company that produces cardboard boxes to take
advantage of internal transfer pricing.
b. A carrier freight company buys a customer service company to handle customer
complaints.
c. A company that specializes in the research and development of new flavor
combinations purchases a candy bar factory.
d. A farm that grows cocoa beans purchases a company that can refine the beans into
cocoa powder that will be available for resale.
Ans: A, LO 4, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with integration, specifically forward vertical. This type of integration involves a company acquiring
another company that exists within the same value chain. Choice A is the only choice listed that accurately depicts a situation where a company is
buying another company within the same value chain that is an integration other than forward vertical. The other choices are forms of forward vertical
integrations.

85. Once companies have decentralized, they find themselves in a position where they will be able
to attempt to establish transfer pricing between internal departments. In order to best
accomplish this, the objectives for the buyer and seller must be considered, even if they are not
fully disclosed to the other party. Which of the following represents a potential transfer price
objective from the perspective of the seller?
a. A seller has no maximum selling price and has the desire to maximize profits.
b. A seller should keep in mind that they will definitely have an alternative market for its
products other than an internal buyer.
 c. The seller has a strong preference for selling to the internal buyer as opposed to an
external, and potentially unfamiliar, vendor.
d. The seller wants to have a selling price that covers variable and fixed manufacturing
costs, at a minimum.
Ans: A, LO 4, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with transfer pricing and the potential objectives from an internal seller’s perspective. Choice A is
the only choice that accurately depicts a potential transfer price objective from the perspective of the seller. The other three choices all contain incorrect
portions of the objective and are not accurate as it pertains to a seller’s objectives.

86. Once companies have decentralized, they find themselves in a position where they will be able
to attempt to establish transfer pricing between internal departments. In order to best
accomplish this, the objectives for the buyer and seller must be considered, even if they are not
fully disclosed to the other party. Which of the following represents a potential transfer price
objective from the perspective of the buyer?
a. The buyer does not have a maximum purchase price in mind and would be willing to
spend more if it meant they could keep all business in-house.
b. The buyer does not have a minimum purchase price in mind, but they would like to
save as much money as possible.
c. If there is an existing supplier in place, then they would prefer to stay with them even
if the internal department offers better pricing.
d. The buyer would be willing to pay more for an internal purchase than an external
equivalent product.
Ans: B, LO 4, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with transfer pricing and the potential objectives from an internal buyer’s perspective. Choice B is
the only choice that accurately depicts a potential transfer price objective from the perspective of the buyer. The other three choices all contain
incorrect portions of the objective and are not accurate as it pertains to a buyer’s objectives.

87. Turner Inc. is a factory that creates laptop bags that contain an added sleeve for increased
protection. The sewing department is currently debating on the best way to proceed with
sourcing the materials needed to create the end product. As compared to purchasing internally,
what is most likely to impact a potential price with an external vendor?
a. High management turnover at the external vendor’s location has caused labor costs
to increase overall.
b. The minimum selling price that the buyer is willing to pay would impact what the
external vendor may charge.
c. The negotiation abilities of the manager arranging the deal with the external vendor
will have the greatest impact.
d. Whether the internal department has any idle capacity or not would have the greatest
impact on the minimum acceptable transfer price.
Ans: C, LO 4, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with how external transfer pricing could be established and what impact the potential price that is
determined. Choice C is the best choice of the four of something that would be most likely to impact a potential price with an external vendor. When a
manager is good negotiator, they will likely have an impact on the price that is offered by the external vendor. The other choices are either less likely or
unlikely to impact the price for an external sale.

88. When companies become decentralized and have additional departments, these departments
will often begin to sell their products internally to one another. A crucial step in the process of
creating a meaningful and worthwhile business relationship is to establish appropriate transfer
prices. Which of the following represents the possible negotiated transfer price?
a. Fixed Manufacturing Costs plus Mark-Up
b. Only Fixed Manufacturing Costs
 c. The minimum price as established by the buyer
d. Variable Manufacturing Costs
Ans: D, LO 4, Bloom: K, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with the continuum of negotiated transfer prices. While all of the choices listed above seem like
definite possibilities, it is only Choice D that is likely to be a possible negotiated transfer price as it appears on the continuum. The other choices
contain elements of what could be included, but they are missing one or more crucial elements to make it complete.

89. One of the potential ways in which transfer pricing can be established is to use market-based
prices, which is often considered an alternative to cost-based transfer prices. In market-based
costing, internal transfer prices may be based upon the same pricing structure offered to
external customers. Of the choices provided below, which is most likely to be indicative of a
pricing system such as market-based transfer pricing?
a. The minimum price as established by the seller
b. Variable manufacturing cost
c. Variable manufacturing cost plus fixed manufacturing cost
d. Variable manufacturing cost plus fixed manufacturing cost plus mark-up
Ans: D, LO 4, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with the continuum of market-based transfer prices. While all of the choices listed above seem like
definite possibilities, it is only Choice D that is likely to be a possible market price as it appears on the continuum. The other choices contain elements
of what could be included, but they are missing one or more crucial elements to make it complete.

90. A company can choose not to set a particular transfer price policy and would instead prefer to
empower business units to negotiate amongst themselves. When this occurs, this opens up the
possibility of many options from the continuum of transfer prices to be an option for pricing. For
this to be accurate, certain conditions exist. Which of the following best represents one of the
conditions that must be present?
a. The market price available to the buyer has to be lower than the variable
manufacturing costs of the seller.
b. The parties’ relative cost structures must not align, and their objectives should vary.
c. The selling unit has available capacity and is not currently selling all of its production
to external customers.
d. The selling unit is currently selling all of its production to external customers.
Ans: C, LO 4, Bloom: K, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with conditions that must be met in order to be able to negotiate a minimum transfer price. Choice
C is the only choice of the four that represents one of the conditions that must be present in order to be able to establish a minimum acceptable
transfer price. The other three choices are either entirely incorrect or at least contain parts that are incorrect.

91. Steven oversees the production department for a factory that makes plastic outdoor chairs.
Currently department sells all of its production to external parties, and the department has an
overall production capacity of 150,000 chairs. Their sales data is as follows: Sales (90,000 chairs)
are $460,000, Variable Costs are $206,200, and Fixed Costs are $194,350. The internal Resale
Division would like to purchase 26,700 chairs from the Production Department. They will be selling
these to external retailers for $15.49 per chair. If the Resale Division negotiates a deal with the
Production Department to purchase each chair for its absorption cost, then what is the amount of
Operating Income the Resale Division would report for their sale of 26,700 chairs? Round per unit
cost to nearest cents.
a. $294,768
b. $352,440
c. $400,500
d. $413,583
Ans: A, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires calculation of negotiated prices and operating income. The first step will be to calculate the
 absorption cost per unit which will be the sum of per unit variable costs and per unit fixed costs. Variable Cost per Unit = $206,200/90,000 chairs = $2.29 per
chair. Next, calculate the Fixed Cost per Unit = $194,350/90,000 chairs = $2.16 per chair. Now, combine these two costs to arrive at the absorption cost per
unit = $2.29 + $2.16 = $4.45 per chair. Next, calculate the Operating Income per unit for the Resale Division = $15.49 – $4.45 = $11.04 per chair. Lastly,
multiply the Operating Income per chair by the 26,700 chairs sold. $11.04 per chair times 26,700 = $294,768 (Choice A).

92. Steven oversees the production department for a factory that makes plastic outdoor chairs.
Currently department sells all of its production to external parties, and the department has an
overall production capacity of 150,000 chairs. Their sales data is as follows: Sales (90,000 chairs)
are $460,000, Variable Costs are $206,200, and Fixed Costs are $194,350. The internal Resale
Division would like to purchase 26,700 chairs from the Production Department. They will be selling
these to external retailers for $15.49 per chair. If the Resale Division negotiates a deal with the
Production Department to purchase each chair for its absorption cost plus a 2.4% markup, then
what is the amount of Operating Income the Resale Division would report for their sale of 26,700
chairs? Round per unit cost to nearest cents.
a. $291,831
b. $293,433
c. $294,768
d. $351,105
Ans: A, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires calculation of Negotiated Prices and Operating Income. The first step will be to calculate
the absorption cost per unit which will be the sum of per unit variable costs and per unit fixed costs. Variable Cost per Unit = $206,200/90,000 chairs = $2.29
per chair. Next, calculate the Fixed Cost per Unit = $194,350/90,000 = $2.16 per chair. Now, combine these two costs to arrive at the absorption cost per
unit = $2.29 + $2.16 = $4.45 per chair. Now, add the 2.4% markup onto the sales price. $4.45 × 1.024 = $4.56 per chair. Next, calculate the Operating
Income per unit for the Resale Division = $15.49 – $4.56 = $10.93 per unit. Lastly, multiply the Operating Income per chair by the 26,700 chairs sold. $10.93
per chair times 26,700 = $291,831 (Choice A).

93. The assembly department of Mifflin Inc. has negotiated a deal with the distribution department
(internal department) to sell them laser printers. The assembly department has operating capacity
of 76,000 printers annually and has made the following external sales:
Sales (76,000 units) $378,000
Direct Materials 49,810
Direct Labor 88,230
Variable Overhead 94,220
Fixed Overhead 112,540

The negotiated deal will be to sell 19,804 printers to the distribution department for the minimum
acceptable transfer price. If the distribution department would like to have an Operating Income of
$32,680, then what is the overall amount of sales that they must have? Do not round intermediate
calculations.
a. $55,454.60
b. $65,745.88
c. $93,280.24
d. $131,178.84
Ans: D, LO 4, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires calculation of the minimum acceptable transfer price and then use of the formula for
Operating Income to be able to calculate desired sales. Since the assembly department is operating at full capacity, their minimum acceptable transfer price
would be equal to market price or the sum of variable cost per unit and the contribution margin per unit. To calculate this, divide the dollar amount of sales
by the number of units sold: $378,000/76,000 printers = $4.97 per unit. Next, calculate the desired sales. Sales – Cost (cost to acquire from assembly
department) = $32,680. Sales – ($4.97 × 19,804) = $32,680. Sales – 98,498.84 = $32,680. Sales = $131,178.84 (Choice D).

94. The assembly department of Mifflin Inc. has negotiated a deal with the distribution department
(internal department) to sell them laser printers. The assembly department has operating capacity
of 76,000 printers annually and has made the following external sales:
Sales (76,000 units) $378,000
Direct Materials 49,810
 Direct Labor 88,230
Variable Overhead 94,220
Fixed Overhead 112,540

The negotiated deal will be to sell 19,804 printers to the distribution department for the minimum
acceptable transfer price. If the distribution department would like to have an Operating Income of
$8,456, then what is the overall amount of sales that they must have? Do not round intermediate
calculations.
a. $98,425.88
b. $106,954.84
c. $127,751.44
d. $136,207.44
Ans: B, LO 4, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires calculating the minimum acceptable transfer price and using the formula for Operating
Income to be able to calculate desired sales. Since the assembly department is operating at full capacity, their minimum acceptable transfer price would be
equal to market price or the sum of variable cost per unit and the contribution margin per unit. To calculate this, divide the dollar amount of sales by the
number of units sold: $378,000/76,000 printers = $4.97 per unit. Now, calculate the desired sales. Sales – Cost (cost to acquire from assembly department)
= $8,456. Sales – ($4.97 × 19,804) = $8,456. Sales – 98,498.84 = $8,456. Sales = $106,954.84 (Choice B).

95. The Production Department of Ollie Corp. has produced and sold 27,840 yards of fabric to local
craft stores. The Sewing Department of Ollie Corp. would like to manufacture 12,300 scarves and
needs fabric. Each scarf will require 1 yard of fabric and the Sewing Department has asked the
Production Department for a quote. The Production Department’s Sales were $35,360, with
Variable Costs of $11,300, Fixed Costs of $16,540, and production capacity of 60,000 yards of
fabric. The negotiated sales price from the Production Department is the absorption cost. What
should the sales price per unit for the Sewing Department be if they would like to have an Operating
Income of $4,940?
a. $0.81 per yard
b. $1.00 per yard
c. $1.40 per yard
d. $1.41 per yard
Ans: C, LO 4, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires calculating the minimum acceptable transfer price and then using the formula for Operating
Income to be able to calculate desired sales and the per yard cost. The negotiated sales price will be the absorption cost which will be equal to the variable
cost per yard plus the fixed cost per yard. Calculate the absorption cost per yard as: ($11,300 + $16,540)/27,840 yards = $27,840/27,840 = $1.00 per yard.
Now, calculate the desired sales. Sales – Cost (cost to acquire from assembly) = $4,940. Sales – ($1.00 × 12,300 yards) = $4,940. Sales – $12,300 =
$4,940. Sales = $17,240. Lastly, divide this by the number of yards sold = $17,240/12,300 yards = $1.40 per yard (Choice C).

96. The Production Department of Ollie Corp. has produced and sold 27,840 yards of fabric to local
craft stores. The Sewing Department of Ollie Corp. would like to manufacture 12,300 scarves and
needs fabric. Each scarf will require 1 yard of fabric and the Sewing Department has asked the
Production Department for a quote. The Production Department’s Sales were $35,360, with
Variable Costs of $11,300, Fixed Costs of $16,540, and production capacity of 60,000 yards of
fabric. The negotiated sales price from the Production Department is the absorption cost. What
should the sales price per unit for the Sewing Department be if they would like to have an Operating
Income of $13,502?
a. $0.10 per yard
b. $1.51 per yard
c. $2.10 per yard
d. $2.91 per yard
Ans: C, LO 4, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires calculating the minimum acceptable transfer price and then using the formula for Operating
Income to be able to calculate desired sales and the per yard cost. The negotiated sales price will be the absorption cost which will be equal to the variable
cost per yard plus the fixed cost per yard. Calculate the absorption cost per yard as: ($11,300 + $16,540)/27,840 yards = $27,840/27,840 = $1.00 per yard.
 Now, calculate the desired sales. Sales – Cost (cost to acquire from assembly) = $13,502 Sales – ($1.00 × 12,300 yards) = $13,502. Sales – $12,300 =
$13,502. Sales = $25,802. Lastly, divide this by the number of yards sold = $25,802/12,300 yards = $2.10 per yard (Choice C).

97. The Saltine Cracker business unit of snack company called Salty Treatz, Inc. is selling all units
produced to external customers. Salty Treatz has a processing capacity of 156,500 units for its
saltine crackers. They have provided the following information:

Sales (118,000 units of $70,800

saltines)
Variable expenses 34,400
Contribution margin $36,400
Fixed expenses 21,200
Operating income $15,200

Due to an increase in sales of Party Platter division, an internal business unit of Salty Treatz,
Party Platter would like to purchase 38,500 of the Saltine Cracker’s product. If Saltine Cracker
does an internal transfer of all additional capacity in units to Party Platter, what will the minimum
acceptable transfer price be?
a. $0.13
b. $0.22
c. $0.29
d. $0.31
Ans: C, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: The minimum acceptable transfer price would be equal to its variable cost per unit. This will be calculated by
dividing the variable expenses by the units of saltine units produced. $34,400/118,000 = $0.29 per unit. They could agree to sell for more, but this is the
amount needed to cover their expenses (Choice C).

98. The Saltine Cracker business unit of snack company called Salty Treatz, Inc. is selling all units
produced to external customers. Salty Treatz has a processing capacity of 156,500 units for its
saltine crackers. They have provided the following information:

Sales (118,000 units of $70,800

saltines)
Variable expenses 34,400
Contribution margin $36,400
Fixed expenses 21,200
Operating income $15,200

Due to an increase in sales of Party Platter division, an internal business unit of Salty Treatz,
Party Platter would like to purchase 38,500 of the Saltine Cracker’s product. If Saltine Cracker
does an internal transfer of all additional capacity in units to Party Platter for the minimum
acceptable transfer price, how much profit could be generated from this sale? (Do not round
intermediate calculation.)
a. $0.00
b. $8,470.00
c. $11,165.00
d. $11,935.00
Ans: A, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: In order to calculate the additional profit, calculate the minimum acceptable transfer price. In the given
scenario, minimum acceptable transfer price would be equal to its variable cost per unit. This will be calculated by dividing the variable expenses by the
units of saltine units produced. $34,400/118,000 = $0.29 per unit. They have additional capacity of 38,500 units, and if they sold them at $0.29 per unit,
 then they would have an additional amount of (38,500 × $0.29) = $11,223.73. Their variable costs would also be $11,223.73, so their total profit would
be $0.00. (Choice A).

99. Pampered Pooches, Inc. is a factory that produces organic dog food and treats. The Oatmeal
Biscuit business unit of Pampered Pooches made all sales of its product to external customers
and is currently operating near their full capacity of 55,000 pounds. Oatmeal reported $42,350 of
sales (50,000 pounds of biscuits), variable expenses of $26,809, and fixed expenses of
$11,504. The Variety Box business unit of Pampered Pooches has asked if the Oatmeal Biscuit
unit could sell them 8,700 pounds of biscuits to include with their upcoming run of new variety
boxes. What will the minimum acceptable transfer price be if they do produce and sell the
demanded pounds to Variety Box?
a. Idle Capacity units - $0.08 per pound, No Idle Capacity units - $0.31 per pound
b. Idle Capacity units - $0.31 per pound, No Idle Capacity units - $0.08 per pound
c. Idle Capacity units - $0.54 per pound, No Idle Capacity units - $0.85 per pound
d. Idle Capacity units - $0.85 per pound, No Idle Capacity units - $0.54 per pound
Ans: C, LO 4, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with how to calculate the minimum acceptable transfer price if a seller has
idle capacity and what the minimum acceptable transfer price would be if a seller has no idle capacity. When there is no idle capacity, the minimum
acceptable transfer price would be equal to its variable cost per unit plus the contribution margin per unit on external sales. Or to simplify, it will be
equal to the market price. This is calculated by dividing the sales by the pounds of biscuits sold. $42,350/50,000 pounds = $0.847 or $0.85 per pound.
For units when there is idle capacity, the minimum acceptable transfer price would be the variable cost per unit: $26,809/50,000 pounds = $0.54 per
pound (Choice C).

100. Pampered Pooches, Inc. is a factory that produces organic dog food and treats. The Oatmeal
Biscuit business unit of Pampered Pooches made all sales of its product to external customers
and is currently operating near their full capacity of 55,000 pounds. Oatmeal reported $42,350 of
sales (50,000 pounds of biscuits), variable expenses of $26,809, and fixed expenses of
$11,504. The Variety Box business unit of Pampered Pooches has asked if the Oatmeal Biscuit
unit could sell them 8,700 pounds of biscuit to include with their upcoming run of new variety
boxes. If Oatmeal Biscuit business unit uses the minimum acceptable transfer price to sell the
required units to Variety Box, what would the total sales price be? (Do not round your
calculations.)
a. $702.00
b. $4,698.00
c. $5,814.80
d. $7,395.00
Ans: C, LO 4, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with how to calculate the minimum acceptable transfer price if a seller has
idle capacity and what the minimum acceptable transfer price would be if a seller has no idle capacity. When there is no idle capacity, the minimum
acceptable transfer price would be equal to the variable cost per unit plus the contribution margin per unit on external sales. Or to simplify, it will be
equal to market price. This is calculated by dividing the sales by the pounds of biscuits sold. $42,350/50,000 pounds = $0.847 or $0.85 per pound. For
units produced when a seller has idle capacity, the minimum acceptable transfer price would be the variable cost per unit. $26,809/50,000 pounds =
$0.54 per pound. There are 5,000 idle capacity units and 3,700 no idle capacity units. (5,000 × $0.54) + (3,700 × $0.85) = $2,680.90 + $3,133.90 =
$5,814.80 (Choice C).

101. Almond Delights is a farm that harvests almonds and sells them to both external customers
and to some internal business units when the deal makes fiscal sense. Almond Delights’ Farm
business unit is having a very successful year and provided the following information:
Sales (167,300 pounds of almonds) $260,988
Direct Materials 15,460
Direct Labor 39,245
Variable Overhead 60,732
Fixed expenses 90,428
 The Almond Milk business unit of Almond Delights would like to purchase 13,490 pounds of
almonds from the Farm business unit. If the Farm business unit is operating at full capacity, then
what will the minimum acceptable transfer price be? (Do not round your calculations.)
a. $0.69 per pound
b. $0.87 per pound
c. $1.56 per pound
d. $1.89 per pound
Ans: C, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with calculating the minimum acceptable transfer price. Since the factory is
already at capacity, the minimum acceptable transfer price would be equal to its variable cost per unit plus the contribution margin per unit on external
sales. Variable cost per unit = ($15,460 + $39,245 + $60,732)/167,300 pounds = $115,437/167,300 pounds = $0.69 per pound. Contribution margin per
unit = ($260,988 – $115,437)/167,300 pounds = $0.87 per pound. The minimum acceptable transfer price is $0.69 + $0.87 = $1.56 per pound (Choice
C).

102. Almond Delights is a farm that harvests almonds and then sells them to both external
customers and to some internal business units when the deal makes fiscal sense. Almond
Delights’ Farm business unit is having a very successful year and provided the following
information:
Sales (167,300 pounds of almonds) $260,988
Direct Materials 15,460
Direct Labor 39,245
Variable Overhead 60,732
Fixed expenses 90,428

The Almond Milk business unit of Almond Delights would like to purchase an additional 13,490
pounds of almonds from the Farm business unit. If Almond Delights Farm business unit is not
operating at full capacity and has the ability to produce all of the additional units, then what will
the minimum acceptable transfer price be to sell to the Almond Milk business unit?
a. $0.33 per pound
b. $0.69 per pound
c. $0.87 per pound
d. $1.56 per pound
Ans: B, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: The minimum acceptable transfer price would be equal to its variable cost per unit. This will be calculated by
dividing the variable expenses by the pounds of almonds harvested. Calculate the total variable costs which will be $15,460 + $39,245 + $60,732 =
$115,437. Now, divide by the number of units sold externally. $115,437/167,300 pounds = $0.69 per pound. They could agree to sell for more, but this
is the minimum amount needed to cover their expenses (Choice B).

103. The retail department of Dunder Corp. has been working out a deal with a new customer, Neal
Inc. The Retail department will be selling ceramic houseplant pots created internally by the
Molding department. The Retail department has agreed to sell 12,430 pots to Neal Inc. at a
price of $157,115.20. The Molding department has been putting together an estimate and noted
that its operating income is $2.64 per unit. If the company would like to see an overall operating
income per unit of $3.98 for both the departments, then what is the sales price of the units
supplied by the Molding department to the Retail department?
a. $12,441.30
b. $32,815.20
c. $107,643.80
d. $140,459.00
Ans: D, LO 4, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires understanding how the overall operating income is calculated when sales involve
internal sales in addition to what the end product is sold for to an external entity. Overall operating income will equal operating income (of the molding
 Department) plus operating income (of the retail department). You can calculate the operating income of retail department from the given information:
$3.98 = $2.64 + Operating income of retail department; Operating income of retail department = $3.98 – $2.64 = $1.34 per unit. Next, multiply the
number of units expected to be sold by the per unit operating income to determine the total amount of operating income of the Retail department:
12,430 pots × $1.34 = $16,656.20. Now, subtract the operating income of the Retail department from the total amount of expected sales to determine
the cost of goods sold for the retail department: $157,115.20 - $16,656.20 = $140,459.00. Cost of goods sold for Retail department will be equal to the
sales from the Molding department to the Retail department (Choice D).

104. The retail department of Dunder Corp. has been working out a deal with a new customer, Neal
Inc. The Retail department will be selling ceramic houseplant pots created internally by the
Molding department. The Retail department has agreed to sell 12,430 pots to Neal Inc. at a
price of $157,115.20. The Molding department has been putting together an estimate and noted
that its operating income is $2.64 per unit. If the company would like to see an overall operating
income per unit of $11.47, then what is the sales price of the units supplied by the Molding
department to the Retail department?
a. $14,543.10
b. $32,815.20
c. $47,358.30
d. $157,115.20
Ans: C, LO 4, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires understanding how the overall operating income is calculated when sales involve
internal sales in addition to what the end product is sold for to an external entity. Overall operating income will equal operating income (of the Molding
department) plus operating income (of the Retail department). Calculate the operating income of the Retail department from the given information:
$11.47 = $2.64 + Operating income of retail department; Operating income of the Retail department = $11.47 – $2.64 = $8.83 per unit. Next, multiply
the number of units expected to be sold by the per unit operating income to determine the total amount of operating income of the Retail department:
12,430 pots × $8.83 = $109,756.90. Now, subtract the operating income of Retail department from the total amount of expected sales to determine the
cost of goods sold for the Retail department: $157,115.20 - $109,756.90 = $47,358.30. Cost of goods sold for the Retail department will be equal to the
sales from the Molding department to the Retail department (Choice C).

105. One of the potential ways that transfer pricing can be established is to use market-based
prices. This is often considered an alternative to cost-based transfer prices. In market-based
costing, internal transfer prices may be based upon the same pricing structure offered to
external customers. Of the choices provided below, which is most likely to be indicative of a
pricing system such as cost-based transfer pricing?
a. Only fixed manufacturing costs
b. The maximum price established by the buyer
c. The minimum price established by the seller
d. Fixed manufacturing costs plus mark-up
Ans: C, LO 4, Bloom: K, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires familiarity with the continuum of cost-based transfer prices. While all of the choices listed above seem like
definite possibilities, it is only Choice C that is likely to be a possible cost-based transfer pricing as it appears on the continuum. The other choices
contain elements of things that could be included but are missing one or more crucial elements to make the responses complete.

106. Income taxes and the IRS present challenges for all businesses, and it is crucial to have
accurate calculations at all times. This scrutiny increases as a company becomes more global. If
a company has divisions in more than one country, then it is known as a multinational company.
When one division crosses national borders, international tax implications arise. Which of the
following represents a challenge that is unique for multinational corporations?
a. Having inbound transactions that are originated by a U.S. based parent company
b. Having outbound transactions that are originated by a foreign parent company
c. Having to navigate the tax regulations of multiple countries as a buyer and seller
d. Having to file corporate tax documents with the Internal Revenue Service
Ans: C, LO 4, Bloom: K, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: This question requires that you be familiar with the special issues encountered by multinational companies that also have transfer
pricing happening across country lines. Choice C is the only choice that is a challenge that is unique to these types of organizations. Choices A and B
are reversed, and Choice D is a challenge that all corporations will have to deal with.
107. The Tortilla Chip business unit at Chipz Corp has reported the following results for years 1 and
2 of their operation:

Year 1 Year 2
Sales $178,903 $194,617
Variable expenses 94,200 103,34
3
Contribution margin $84,703 $91,274
Fixed expenses 50,732 55,892
Operating income $33,971 $35,382

The Tortilla Chip business unit sold 69,870 bags in Year 1, and they sold 75,433 bags in Year 2.
In the first year, they had an operating capacity of 75,000 bags and fulfilled a special order for
an internal department of 12,465 bags. In the second year, they had an operating capacity of
80,000 bags and fulfilled a special order for an internal department of 14,788 bags. What is the
difference in overall price for the special orders fulfilled for the internal department in years 1
and 2? (Round per unit cost to two decimal places.)
a. Year 1 is $6,923.87 higher than Year 2
b. Year 1 is $7,592.58 higher than Year 2
c. Year 2 is $6,923.87 higher than Year 1
d. Year 2 is $7,592.58 higher than Year 1
Ans: C, LO 4, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires calculation of the minimum acceptable price for both idle capacity and no idle
capacity. This will result in two different minimum acceptable transfer prices. These calculations must be completed for both years.
Year 1: To determine how many are subject to each price, subtract the sales from the high threshold of the capacity. 75,000 – 69,870 = 5,130 units can
still be produced before hitting capacity. The minimum acceptable transfer price of the 5,130 units will be equal to the variable cost per unit, which is
equal to $94,200/69,870 = $1.35 per unit. Any units produced with no idle capacity will have a minimum acceptable transfer price of the variable cost
per unit plus the contribution margin per unit. Contribution margin = $84,703. Now, divide this by the units sold: $84,703/69,870 bags = $1.21 per unit.
The minimum acceptable transfer price = $1.35 + $1.21 = $2.56 per unit. The number of units that will be charged at this price will be the total
requested minus the units with idle capacity = 12,465 – 5,130 = 7,335 units. The total price that will be quoted is: (7,335 × $2.56) + (5,130 × $1.35) =
$18,777.6 + $6,925.5 = $25,703.10.
Year 2: To determine how many are subject to each price, subtract the sales from the high threshold of the capacity. 80,000 – 75,433 = 4,567 units can
still be produced before hitting capacity. The minimum acceptable transfer price of the 4,567 units will be equal to the variable cost per unit, which is
equal to $103,343/75,433 = $1.37 per unit. Any units produced with no idle capacity will have a minimum acceptable transfer price of the variable cost
per unit plus the contribution margin per unit. Contribution margin = $91,274. Now, divide this by the units sold: $91,274/75,433 = $1.21 per unit. The
minimum acceptable transfer price = $1.37 + $1.21 = $2.58 per unit. The number of units that will be charged at this price will be the total requested
minus the units with idle capacity = 14,788 – 4,567 = 10,221 units. The total price that will be quoted is: (10,221 × $2.58) + (4,567 × $1.37) =
$26,370.18 + $6,256.79 = $32,626.97.
Overall price difference: $32,626.97 – $25,703.10 = $6,923.87 (Choice C).

108. The Tortilla Chip business unit at Chipz Corp has reported the following results for years 1 and
2 of their operation:

Year 1 Year 2
Sales $178,903 $194,617
Variable expenses 94,200 103,34
3
Contribution margin $84,703 $91,274
Fixed expenses 50,732 55,892
Operating income $33,971 $35,382

The Tortilla Chip business unit sold 69,870 bags in year one, and they sold 75,433 bags in their
second year. In the first year, they had operating capacity of 75,000 bags and fulfilled a special
order for an internal department of 12,465 bags. In the second year, they had operating capacity
of 80,000 bags and fulfilled a special order for an internal department of 14,788 bags. Which of
 the following is an accurate representation of the difference in minimum acceptable transfer
price between the two years? (Round per unit cost to two decimal places.)
a. With idle capacity, the unit transfer price is $0.02 higher in Year 1 than Year 2.
b. With idle capacity, the unit transfer price is $0.02 higher in Year 2 than Year 1.
c. With no idle capacity, the unit transfer price is $0.04 higher in Year 1 than Year 2.
d. With no idle capacity, the unit transfer price is $0.04 higher in Year 2 than Year 1.
Ans: A, LO 4, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires calculation of the minimum acceptable price for both idle capacity and no idle
capacity. This will result in two different minimum acceptable transfer prices. These calculations must be completed for both years. These are needed
to perform comparison calculations.

Year 1: To determine how many are subject to each price, subtract the sales from the high threshold of the capacity. 75,000 – 69,870 = 5,130 units can
still be produced before hitting capacity. The minimum acceptable transfer price of the 5,130 units will be equal to the variable cost per unit, which is
equal to $94,200/69,870 = $1.35 per unit. Any units produced with no idle capacity will have a minimum acceptable transfer price of the variable cost
per unit plus the contribution margin per unit. Contribution margin = $84,703. Now, divide this by the units sold: $84,703/69,870 = $1.21 per unit. The
minimum acceptable transfer price = $1.35 + $1.21 = $2.56 per unit.

Year 2: To determine how many are subject to each price, subtract the sales from the high threshold of the capacity. 80,000 – 75,433 = 4,567 units can
still be produced before hitting capacity. The minimum acceptable transfer price of the 4,567 units will be equal to the variable cost per unit, which is
equal to $103,343/75,433 = $1.37 per unit. Any units produced with no idle capacity will have a minimum acceptable transfer price of the variable cost
per unit plus the contribution margin per unit. Contribution margin = $91,274. Now, divide this by the units sold: $91,274/75,433 = $1.21 per unit. The
minimum acceptable transfer price = $1.37 + $1.21 = $2.58 per unit.

Difference in minimum acceptable transfer price with no idle capacity: Year 2: $2.58 – Year 1: $2.56 = $0.02.
Difference in minimum acceptable transfer price with idle capacity: Year 2: $1.37 – Year 1: $1.35 = $0.02.
In both the scenarios, Year 2’s minimum acceptable transfer price is $0.02 higher than Year 1 (Choice A).

109. A factory has several business units and is vertically integrated throughout most of its supply
chain. One of the first ways the company moved in this direction was to purchase a Wholesale
department where the Production department could directly sell its products. The Wholesale
department purchases the final product from the Production department, packages the product,
and then sells it to the external vendors. The results of this part of the operation are as follows:

Production Wholesale
Sales $56,000 $111,040
Variable expenses 28,600 62,479
Contribution margin $27,400 $48,561
Fixed expenses 19,745 26,701
Operating income $7,655 $21,860

There is currently no external market for the Production department to sell its products, so all
sales are from the 80,000 units sold to the Wholesale department. The product created by the
Production department is very unique, and the Wholesale department cannot acquire it from
another vendor or supplier. Assuming that the Production department uses the minimum
acceptable transfer price, how much total variable costs are they incurring per unit once the
Wholesale department sells overall?
a. $0.08
b. $0.44
c. $0.78
d. $1.14
Ans: B, LO 4, Bloom: AP, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: This question requires familiarity with calculating results once you factor in that part of the sale and costs
between two departments within the same organization. To calculate this, it is best to determine the per unit cost of each number that will be needed.
The variable costs from the Production department are needed to calculate the overall variable cost per unit. $28,600/80,000 units = $0.36 per unit. To
calculate the additional variable costs incurred by the Wholesale department, subtract the transfer price from the variable costs, and divide by units
sold. ($62,479 – $56,000)/80,000 units = $6,479/80,000 units = $0.08 per unit. Total variable cost per unit would be: $0.36 + $0.08 = $0.44 (Choice B).
110. A factory has several business units and is vertically integrated throughout most of its supply
chain. One of the first ways the company moved in this direction was to purchase a Wholesale
department where Production could directly sell its products. The Wholesale department
purchases the final product from the Production department, packages the product, and then
sells it to the external vendors. The results of this part of the operations are as follows:

Production Wholesale
Sales $56,000 $111,040
Variable expenses 28,600 62,479
Contribution margin $27,400 $48,561
Fixed expenses 19,745 26,701
Operating income $7,655 $21,860

Currently, there is no intermediate market for the Production department to sell its products, so
all of the sales are from the 80,000 units sold to the Wholesale department. The product created
by the Production department is very unique, and the Wholesale department cannot acquire it
from another vendor or supplier. Assume that the Production department finds an external
vendor and can sell 40,000 units of its products for $0.72 per unit and that there was no change
in the Production department’s current transfer price. Then, what is the percentage change in
operating income that they would see?
a. 10.45% increase
b. 17.29% decrease
c. 17.29% increase
d. 20.9% decrease
Ans: A, LO 4, Bloom: AP, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: Under the given conditions, the Production department is reporting operating income of $7,655 by selling all
products to the internal Wholesale department. If they found themselves with an external customer that would receive $0.72 per unit for the order of
40,000 units, then this would create sales of 40,000 × $0.72 per unit = $28,800. Next, calculate the sale generated from the wholesale department:
40,000 × 0.70 per unit = $28,000. Now, calculate the new operating income: $28,800 + $28,000 – $28,600 – $19,745 = $8,455. The percentage
change can be measured as follows: ($8,455 – $7,655)/$7,655 = 0.1045 or 10.45% increase (Choice A).

Short Answers

111. State the four pillars of a management control system, and indicate how each fits into the
overall design of an effective system and why it is crucial that they all function together.
Ans: NA, LO 1, Bloom: C, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: The four pillars of a management control system are: Budgeting, Responsibility Centers, Transfer Pricing, and Performance
Measurement. Each of the pillars contains its own unique attributes but must also work together to create a complete and comprehensive system
designed to help a business achieve its goals. Budgeting strives to create numerical goals that will guide other processes such as staffing and
production. Responsibility Centers divide tasks between various employees and departments to ensure that necessary work is being completed.
Transfer Pricing is used as a means to coordinate activities between and within business units, and it aims to fulfill these business units’ and the
company’s objectives. Performance Measurement reflects upon a process from start to finish and determines whether certain goals or metrics have
been achieved. Management can then provide additional guidance to make effective changes moving forward based on the results of measured
performance. A truly effective system will have all four pillars working with and building upon one another. It is crucial that they function together as
they have special mechanisms to guide employee decision-making and therefore company goals.

112. What is a responsibility center, and what are the four types? Discuss each in detail.
Ans: NA, LO 2, Bloom: K, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: A responsibility center is a unit within a business that is organized by its area of control. The four types of responsibility centers are:
cost center, revenue center, profit center, and investment center. A cost center has the objective of managing costs while fulfilling its purpose within the
value chain as defined by the company. A revenue center has the task of generating revenues for a company, and its sole purpose is to generate sales
within the parameters set by the company. A profit center has a defined responsibility of earning a profit, which entails generating revenues and
simultaneously maintaining expenses. Investment centers have the assigned task of generating a target return with selected assets and then
 reinvesting the subsequent returns. Each responsibility center has its own tasks but creates a well-balanced company and management system when
all centers are functioning as designed.

113. What are the three characteristics of effective responsibility centers, and what does each
entail? Why are these characteristics so important to the overall functioning of responsibility
centers of decentralized organizations?
Ans: NA, LO 2, Bloom: AN, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: The three characteristics of effective responsibility centers include authority, responsibility, and accountability. Authority initially
resides at the top levels of a company before it is delegated to middle and lower levels of management in a decentralized organization. The goal of
authority is to empower employees to make good decisions with consequences given by management when goals are not achieved. Responsibility
entails being given ownership over a task or process where the responsibility of completion is shared by the owner of the task and the person that
delegated it to them, typically a manager. Accountability is related to responsibility but is different in that accountability is needed to move responsibility
from a suggestion to a real goal with enforceable consequences. These characteristics are integral to the overall functioning of responsibility centers of
decentralized organizations because they all build upon one another and work in tandem. In a well-structured organization, these characteristics can
flow upward and/or downward in support of goal congruence.

114. Company and employee performances are best measured through both quantitative and
qualitative measures. Why are both components important to the overall picture of
performance? Why are ratios the most fair and consistent means of comparing different
organizations within the same industry?
Ans: NA, LO 3, Bloom: AN, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: When it comes to measuring the performance of an organization, it is crucial that as much bias as possible be eliminated. If you
were to only observe quantitative data, such as ratios, without also considering qualitative factors, then an incorrect conclusion might be drawn. For
example, a manager may measure labor percentages and note that one department has exceptionally high numbers. Upon further inquiry, this
manager might learn that employees have been working overtime to compensate for so many people being out sick which is costing the company time
and extra overtime wages that are one and one-half times higher than the normal labor rate. When this is factored in, the managers might actually be
performing well given the circumstances. The overall picture of performance is nuanced and should be approached as such. Ratios are the fairest and
most consistent means of comparing different organizations within the same industry as they remove biases like size and create a level playing field for
comparison.

115. What is vertical integration, and when is it present in a business? What are the different
directions associated with vertical integration, and how does each impact your position in the
value chain as it relates to the customer?
Ans: NA, LO 4, Bloom: K, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: Vertical integration often arises as a result of a merger of two companies or an acquisition where one company buys another with a
focus on one company’s value chain. Vertical integration typically results when a company finds value in taking direct ownership of various activities
that either precede or follow the existing firm in the value chain. Vertical integration can be upstream when the company is before you in the value
chain and therefore further away from the final customer. Vertical integration can also be downstream when the company that is after you is in the
value chain and therefore closer to the final customer.

116. What is transfer pricing, and why is it necessary? What is required before negotiating an
optimal transfer price range?
Ans: NA, LO 4, Bloom: K, Difficulty: Medium, AACSB: Communication, AICPA: AC: Reporting, IMA: Strategy, Planning, & Performance: Decision
Analysis. Solution: Transfer pricing is the internal transaction price at which goods or services are exchanged between two business units within the
same company. The need to establish a transfer price arises when two parties to a transaction are related business units within the same company.
These related business units use transfer pricing as a means to allocate total profit between them. The process will still deem one party/business unit
as the seller and the other party/business unit as the buyer even though the transaction occurs within the same company. Before being able to
establish or negotiate an optimal transfer price range, establish the buyer’s and seller’s objectives while also determining the capacity constraints of
each. Establishing objectives involves thinking of the perspective of each party and then determining if an acceptable price range can be established
between both parties. Determining capacity constraints involves observing supply and demand in both the internal and external markets while also
factoring in any intermediate markets that might exist.

Brief Exercise

117. Shannon is a manager for Smith Corp., a factory that manufactures cotton scarves in a variety
of colors and patterns. Her division is in charge of dying the fabric, and she would like to explore
the possibility of replacing one of their machines. The current machine is attributed with $4,500
of sales, has $1,404 of operating expenses, and has a repair cost of $4,600. A new machine is
 estimated to generate $5,400 of sales, to have $2,560 of operating expenses, and has a cost of
$4,850. What is the Return on Investment in each scenario?
Ans: NA, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: Retain and Repair: 67.30%, Purchase New: 58.56%

This question requires familiarity with the formula for Return on Investment: (Operating Income/Sales) × (Sales/Investment) where sales cancel one
another out. To retain and repair the current machine: ($4,500 – $1,404)/$4,600 = 0.6730 or 67.30%. To purchase a new machine: ($5,400 –
$2,560)/$4,850 = 0.5856 or 58.56%.

118. Forager Ltd. is a company that creates various home décor items including faux houseplants,
planters, and picture frames. All the items they produce are created using recycled materials,
and that has been a major selling point for their customers. The manager of the planter division
requested that they look into purchasing a new kiln that will reduce production time and costs
while increasing output. The head accountant has compiled the following estimates pertaining to
the new kiln: Sales, $4,675; Cost of Goods Manufactured, $1,844; and Operating Expenses
(including depreciation), $1,408. The cost of the kiln is estimated to be $9,630. What are the
Return on Sales and the Investment Turnover values for a new kiln?
Ans: NA, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: Return on Sales: 0.3044, Investment Turnover: 0.4855

This question requires calculation of both the Return on Sales and the Investment Turnover. Return on Sales is calculated as follows: Operating
Income/Sales. Investment Turnover is calculated as follows: Sales/Investment. Begin with Return on Sales. Operating Income is calculated by
subtracting Cost of Goods Manufactured and Operating Expenses from Sales. Operating Income = $4,675 – $1,844 – $1,408 = $1,423. Now, divide
that value by Sales to calculate the Return on Sales $1,423/$4,675 = 0.3044. Then, calculate Investment Turnover, $4,675/$9,630 = 0.4855.

119. Susan is considering the purchase of a new machine for her division at work. They had a
busier year than expected, and that expedited wear and tear on the existing machine used by
her division. She argued that purchasing a new machine instead of fixing the current machine
would be the smarter investment for the company. Susan pulled together some information
about the new machine (all figures listed are specifically tied to the new machine):
Sales: $2,428
Operating Expenses: $1,870
Cost (new machine): $9,764

The company has a Required Rate of Return of 5%. What is the Residual Income that would be
generated by the new machine?
Ans: NA, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: Residual Income: $69.80

This question requires calculation of Residual Income for an investment. The formula is as follows: Operating Income – (Required Rate of Return ×
Investment). The first step is to calculate the Operating Income: $2,428 – $1,870 = $558. Now, complete the rest of the formula. $558 – (5% × $9,764)
= $558 – $488.20 = $69.80.

120. Tate is the manager for the service division at Wilcox Inc., a company that provides a call
center for various customer service organizations. They are in the process of analyzing some
data for the current year and want to ensure that they are making wise choices. Their
accountant has compiled the following information about certain financial statement balances:
Current Assets = $10,000
Total Assets = $35,000
Current
Liabilities = $14,500
Total Liabilities = $18,000
 Wilcox purchased a new phone system this year that cost them $6,700. They would like to
calculate the Economic Value Added (EVA) but must first perform some sub-calculations. What
is the invested capital value when calculating the EVA for the entire division? What about the
new phone system?
Ans: NA, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: Entire Division: $20,500, New Phone System: $6,700

This question requires familiarity with the way that invested capital is calculated under different circumstances. For the entire division, the formula is
Total Assets – Current Liabilities. Entire Division: $35,000 – $14,500 = $20,500. When EVA is calculated using a specific investment, such as a new
phone system, use the cost of the investment. In this case, that amount is $6,700.

121. Dottie is compiling some data for her boss who is interested in comparing last year to the
current year. They will eventually work on calculating the Economic Value Added (EVA) by the
new industrial assembly line conveyer belt added but must first determine their Weighted
Average Cost of Capital (WACC). Dottie has gathered the following information:

Current Previous
Year Year
Cost of Debt 6.5% 6.00%
Cost of Equity 8.5% 8.25%
80.0
Proportion of Debt % 78.00%
Proportion of 20.0
Equity % 22.00%

What is the WACC for the current year? What is the WACC of the previous year? (Do not round
intermediate calculations.)
Ans: NA, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: Current Year: 6.90%, Previous Year: 6.50%
In order to solve for the WACC, apply the following formula: (Cost of Debt × Proportion of Capital Financed with Debt) + (Cost of Equity × Proportion of
Capital Financed with Equity). For the current year: (0.065 × 0.80) + (0.085 × 0.20) = 0.052 + 0.017 = 0.069, or 6.90%. For the previous year: (0.06 ×
0.78) + (0.0825 × 0.22) = 0.04680 + 0.01815 = 0.06495, or 6.50%.

122. Jenna has decided to demonstrate to her manager that the new embroidery machine they
purchased was a great investment for the company where they work. Management had
originally wanted to repair the existing machine, but Jenna convinced them that acquiring a
more modern machine would be a great fiscal decision. She is going to calculate the Economic
Value Added (EVA) in the hopes that her prediction was correct. She has gathered the following
data:

Embroidery machine $8,650

Expected Operating Income tied to the embroidery
machine $794
Tax rate 21%
Cost of Debt 7%
Proportion of Debt 82%
Cost of Equity 7.8%
Proportion of Equity 18%

Using the information above, what is the EVA that Jenna will be able to present to
management?
 Ans: NA, LO 3, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: EVA = $9.30
This question requires the formula for EVA which is After-Tax Operating Income – (WACC × Investment). First, calculate WACC by using the following
formula: (Cost of Debt × Proportion of Capital Financed with Debt) + (Cost of Equity × Proportion of Capital Financed with Equity). (0.07 × 0.82) +
(0.078 × 0.18) = 0.0574 + 0.0140 = 0.0714. Now, complete the formula for EVA: (($794 × (1 – 0.21)) – (0.0714 × $8,650) = $627.26 – $617.956 =
$9.30.

123. Sarah is the production manager for Smith Corp., and she is working on some pricing
proposals for internal and external customers. Sarah is in charge of the Red Business Unit who
produces spools of red yarn. They currently supply many craft stores in the area, have had a
very busy year, and are operating at capacity. The manager of the Scarf Division, an internal
business unit for Smith Corp. has asked if Sarah could fill an order for 5,700 spools of red yarn
for them. Sarah has collected the following information to determine how to proceed: Sales to
external customers (32,900 spools): $156,780, Variable Costs: $109,570, and Fixed Costs:
$33,662. If Sarah wants to provide a quote to the Scarf Division, what is the minimum
acceptable transfer price? (Do not round intermediate calculations.)
Ans: NA, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: Minimum acceptable transfer price = $4.77

This question requires determining what amounts would factor into the minimum acceptable transfer price. Since Smith Corp. is currently operating at
capacity and has no idle capacity, this means that internal buyers, including the Scarf Division, must pay the equivalent of the market price: variable
cost per unit + contribution margin per unit on external sales. The latter part of this formula is also known as the opportunity cost, and that is how it is
identified in this problem. To solve for the opportunity cost, subtract the variable costs from the sales and divide by the number of units sold externally:
($156,780 – $109,570)/32,900 = $47,210/32,900 = $1.43 contribution margin per unit. Variable cost per unit: $109,570/32,900 = $3.33. Therefore, the
minimum acceptable transfer price = $3.33 + $1.43 = $4.77.

124. The Paper business unit of Home Supplies Inc. has had a busy year and has reported sales of
174,300 pounds of fully processed paper for $98,754. They also incurred $55,320 worth of
variable expenses and are currently operating at capacity. The Plate division of Home Supplies
Inc. would like to purchase 7,487 pounds of paper internally from the Paper business unit to
continue making durable paper plates. The Paper division is considering taking on this order
and has decided that a 12% markup would be needed to satisfy their own internal needs. The
Plate division said that they won’t pay more than $4,800 total for this deal. What is the minimum
acceptable transfer price? Will this be a deal that the Paper division can proceed with? (Round
all calculations to two decimal places.)
Ans: NA, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: Minimum Acceptable Transfer Price = $0.64 per pound; Yes, this is a deal that the Paper division would
proceed with since the overall price they would charge of $4,791.68 is less than the $4,800.00 that the Plate division would pay.

This question requires determination of the minimum acceptable sales price under the circumstances presented, calculation of the marked-up price,
and a decision about whether or not this deal can come to fruition based on the limit placed on the overall price by the buyer. When the seller is at
capacity, the minimum acceptable transfer price will be the variable cost per unit plus the contribution margin per unit on external sales. Variable Cost
per Unit: Total Variable Costs/Units Sold Externally = $55,320/174,300 pounds = $0.32 per pound. Contribution Margin per Unit on External Sales =
(Sales – Variable Costs)/Units Sold Externally = ($98,754 – $55,320)/174,300 pounds = $43,434/174,300 pounds = $0.25 per pound. The minimum
acceptable transfer price is ($0.32 + $0.25) × 1.12 = $0.57 × 1.12 = $0.64 per pound. The overall price of this sale would be $0.64 × 7,487 pounds =
$4,791.68. At this price, the overall cost is less than the overall amount that the Plate Division stated they were willing to pay.

125. Stellar Notes is a factory that produces fun and colorful writing utensils marketed to students.
Within the company, there are various business units including a Plastic Cap Division and a Pen
Division. Tara, the production manager of the Pen division has been updating their production
worksheets and realized that they will run out of caps before they have satisfied their current
orders. They normally purchase their caps from a special supplier, but they are going to ask the
internal Plastic Cap Division to see if they can assist with an order of 2,643 pen caps to meet
the existing need. The Plastic Cap Division has a production capacity of 88,543 caps, and they
have sold 87,433 caps to external customers resulting in external sales of $134,660. They had
variable costs of $96,543. If the Plastic Cap Division provided a quote for the caps requested
 internally, what will the overall price quoted by Plastic Cap Division be for the 2,643 caps
requested?
Ans: NA, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: Overall Price: $3,581.82

This problem requires familiarity with the formula for the minimum acceptable transfer price when a factory has both idle capacity and when it has no
idle capacity. This will result in two different minimum acceptable transfer prices. To determine how many are subject to each price, you will subtract
the current production from the highest threshold of their capacity. 88,543 – 87,433 = 1,110 caps can still be produced before hitting their capacity limit.
The minimum acceptable transfer price of those 1,110 caps will be the Variable Cost per Unit: $96,543/87,433 caps = $1.10 per unit. The remaining
units in this order will have a minimum acceptable transfer price of the variable cost per unit plus the contribution margin per unit. Contribution Margin =
Sales – Variable Costs = $134,660 – $96,543 = $38,117. Now, divide this total by the number of units sold externally: $38,117/87,433 caps = $0.44 per
unit. Therefore, the minimum acceptable transfer price will be $1.10 + $0.44 = $1.54 per unit. The number of units that will be charged at this price will
be the total requested minus the units produced below their capacity threshold: 2,643 – 1,110 = 1,533 caps. Thus, the total price quoted is: (1,110 ×
$1.10) + (1,533 × $1.54) = $1,221.00 + $2,360.82 = $3,581.82.

126. The Assembly department of a factory has been asked to put together a sales quote for the
Sales department, which is an internal division at the same company. The Assembly department
has reported the following external sales information:
Sales (14,300 units) $38,930
Direct Labor 8,650
Direct Materials 6,304
Variable Overhead 9,998
Fixed Overhead 11,270

The Assembly department has an operating capacity of 14,300 units. The Sales department
would like to purchase 5,000 units from the Assembly department. What is the minimum
acceptable transfer price, and the absorption cost per unit? (Do not round intermediate
calculations.)
Ans: NA, LO 4, Bloom: AP, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: Minimum acceptable transfer price is $2.72 per unit; and Absorption cost per unit is $2.53.

This question requires familiarity with calculating various costs for the same order from the perspective of the internal seller. Since the Assembly
department is currently operating at capacity, the minimum acceptable transfer price would be equal to the market price: $38,930/14,300 units = $2.72.
To determine the absorption cost per unit, first calculate the overall variable costs: $8,650 + $6,304 + $9,998 = $24,952. Now, divide by the units sold
externally to arrive at the variable cost per unit: $24,952/14,300 units = $1.74 per unit. Next, determine the fixed cost per unit as = $11,270/14,300 units
= $0.79 per unit. Now, add fixed cost per unit to the variable cost per unit to get the absorption cost per unit: $1.74 + $0.79 = $2.53.

127. Janice is in charge of the Staining department of a local woodworking business. She is
ramping up for what is likely to be her busiest year so far. She anticipates that the department
will need 18,000 oak planks to meet their order fulfillment. The internal Materials department
would be able to fulfill half of this order before it meets its capacity and has reported the
following information about their external sales:
Sales (21,000 planks) $114,206
Variable Costs 42,840
Fixed Costs 57,600

The Materials department has agreed to a negotiated sales price of the minimum acceptable
transfer price. An external vendor has also said it could fulfill the other half for $2.15 per plank,
or they would agree to $2.10 if Janice bought all 18,000 planks from them. What is the
difference in overall price if Janice purchases half internally and half externally versus
purchasing all planks externally? Do not round intermediate calculations.
Ans: NA, LO 4, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: Overall difference in price is $90 higher for the external-only order.

This question requires familiarity with calculating the minimum acceptable transfer price and overall price in multiple situations. In this case, the
Materials department has idle capacity so the minimum acceptable transfer price would be equal to the variable cost per unit. $42,840/21,000 planks =
$2.04 per plank. The overall price for the half-internal and half-external order would be: (9,000 × $2.04) + (9,000 × $2.15) = $18,360 + $19,350 =
 $37,710. The overall total for the purchase with all 18,000 units coming from the external vendor would be: 18,000 × $2.10 = $37,800. The difference in
price would be $37,800 – $37,710 = $90 higher for external only.

128. After much consideration, Trina has decided sever ties with her current plastic bottle supplier
due to consistent shipping delays and yearly price increases. She has put inquiries in with a
different external vendor who has agreed to a pricing structure as follows: first 12,000 bottles at
$0.82 per bottle, next 10,000 bottles at $0.80 per bottle, next 12,000 bottles at $0.77 per bottle,
and any remaining bottles at $0.72 per bottle. They will also ask for a 10% surcharge to cover
shipping and handling. The internal Materials department has also provided a quote to Trina for
the bottles needed. The Materials department has reported the following external sales data for
this year: Sales (of 203,450 bottles) at $181,070.50, Variable Costs of $140,380.50, and Fixed
Costs of $22,640.50. The Materials department has an operating capacity of 250,000 bottles
and has agreed to supply the bottles at the minimum acceptable transfer price. Trina’s
department needs 78,903 bottles in order to fulfill all of their upcoming orders. What is the
average cost per unit under both the price quote from the external vendor and from the internal
department? (Do not round intermediate calculations.)
Ans: NA, LO 4, Bloom: AP, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution: Average Cost per Unit for the External Supplier is $0.83, and for the Internal Department is $0.77.

This question requires familiarity with the formula for the minimum acceptable transfer price in addition to calculating an average per unit costs under
different circumstances.

External Supplier: This overall cost must be calculated in layers: (12,000 × $0.82) + (10,000 × $0.80) + (12,000 × $0.77) + ((78,903 – 34,000) × $0.72)
= $9,840 + $8,000 + $9,240 + $32,330.16 = $59,410.16 total cost. Now, add the surcharge: $59,410.16 × 1.10 = $65,351.18. Lastly, divide this number
by the number of bottles needed to arrive at the average cost per unit: $65,351.18/78,903 bottles = $0.83 per bottle.

Internal Department- This overall cost must be calculated in layers. Some units are produced with idle capacity, and some are not. The idle capacity
units will have a minimum acceptable transfer cost of the variable cost per unit and the over idle capacity units will have a minimum acceptable transfer
cost of the variable cost per unit plus the contribution margin per unit. Variable cost per unit = $140,380.50/203,450 bottles = $0.69 per bottle.
Contribution margin per unit = ($181,070.50 – $140,380.50)/203,450 bottles = $0.20. Cost of idle capacity units = 250,000 – 203,450 = 46,550 × $0.69
= $32,119.50. Over idle capacity units = 78,903 – 46,550 = 32,353 × ($0.69 + $0.20) = $28,794.17. Now, calculate total cost: $32,119.50 + $28,794.17
= $60,913.67. Lastly, divide this number by the number of bottles needed to arrive at the average cost per unit: $60,913.67/78,903 bottles = $0.77 per
bottle.

Exercises

129. Dot Co. is a paint company, and it just completed its second quarter and is performing some
analysis so that it can evaluate its top two paint divisions: Latex and Oil-Based. In their third
quarter, the company has decided that it can give one or both divisions $15,000 of cash for
investments if the analysis support it. Dot has requested that their head accountant gather some
financial statement data and analyze it before they move forward with any potential investments.
The accountant has compiled the following condensed income statements and selected balance
sheet information for the second quarter:

Latex Oil-Based
Sales $776,450 $548,010
COGS 402,300 306,70
8
Gross Margin $374,150 $241,302
Operating Expenses 301,900 198,65
0
Operating Income $72,250 $42,652

In the second quarter, each division purchased a new piece of mixing equipment that cost
$286,000. The company’s effective tax rate is 23%, it has a Required Rate of Return of 8.5%,
 and its Weighted Average Cost of Capital (WACC) is 7.6%. Use this information to answer the
following questions.

a. What are the Return on Investment (ROI), Residual Income (RI), and the Economic Value
Added (EVA) for the Latex Division?
b. What are the Return on Investment (ROI), Residual Income (RI), and the Economic Value
Added (EVA) for the Oil-Based Division?
c. Based on this initial analysis, will either department be granted money to pursue the additional
investment?
Ans: NA, LO 1, 3, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution:
a. ROI = 25.26%, RI = $47,940.00, and EVA = $33,896.50

This question requires familiarity with three different formulas: ROI, which is operating income divided by Investment; RI, which is Operating Income –
(Required Rate of Return × Investment); and EVA, which is After-Tax Operating Income – (WACC × Investment). ROI = $72,250/$286,000 = 0.2526 or
25.26%. RI = $72,250 – (0.085 × $286,000) = $72,250 – $24,310 = $47,940. EVA = ($72,250 × (1 – 0.23)) – (0.076 × $286,000) = $55,632.50 –
$21,736 = $33,896.50.

b. ROI = 14.91%, RI = $18,342.00, EVA = $11,106.04

This question requires familiarity with three different formulas: ROI, which is operating income divided by investment; RI, which is Operating Income –
(Required Rate of Return × Investment); and EVA, which is After-Tax Operating Income – (WACC × Investment). ROI = $42,652/$286,000 = 0.1491 or
14.91%. RI = $42,652 – (0.085 × $286,000) = $42,652 – $24,310 = $18,342. EVA = ($42,652 × (1 – 0.23)) – (0.076 × $286,000) = $32,842.04 –
$21,736.00 = $11,106.04.

c. Based on this initial analysis, it would appear that both the Latex division and the Oil-Based division would be eligible to obtain the investment. This is
because the Returns on Investment are 25.26% and 14.91%, respectively, both of which are higher than the required rate of return of 8.5%. Both
divisions also have positive Residual Income and Economic Value Added, and that means that their metrics are strong enough to be allowed to have
the additional funding offered by the company.

130. Jonathan is the manager of the equipment rental section of a large hardware store. Many
customers have been requesting industrial wood floor sanders. Jonathan would be able to
purchase one for the company for $3,675, but he knows that there are other costs and factors to
consider. He believes that the sander would generate $1,342 of rental income in its first year
and would incur $433 of expenses (not including depreciation). The sander has a 10-year useful
life, and Jonathan suggests the use of straight-line depreciation. Jonathan is going to run some
analysis prior to making a final suggestion to the store.

(Do not round intermediate calculations.)

a. What is the Return on Investment (ROI) for the industrial wood floor sander using the DuPont
method?
b. How much Residual Income (RI) will the sander generate if the Required Rate of Return is 8%?
c. Jonathan’s section earned 15% ROI last year. If his evaluation is based upon ROI, then would
he be likely to pursue the purchase of this Industrial Wood Floor Sander? Please explain your
rationale.
Ans: NA, LO 1, 3, Bloom: E, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution:

a. ROI = 14.73%

This question requires familiarity with the formula for calculating ROI using the DuPont method: Profit Margin × Investment Turnover. Profit margin =
Operating Income/Sales. First, calculate the yearly depreciation to update expenses, and determine an accurate Operating Income. The company is
using straight-line depreciation calculations. Annual depreciation is $3,675/10 years = $367.50. Operating Income = $1,342.00 – ($433.00 + $367.50) =
$541.50. Now, calculate the profit margin. $541.50/$1,342.00 = 0.4035. Next, calculate Investment Turnover: Sales/Investment, or $1,342/$3,675 =
0.3652. Lastly, calculate the ROI: 0.4035 × 0.3652 = 0.1473 or 14.73%.

b. Residual Income = $247.50

This question requires familiarity with the formula for Residual Income: Operating Income – (Required Rate of Return × Investment). Operating Income
was calculated for part a, so it can be used here as well. Residual Income = $541.50 – (0.08 × $3,675.00) = $541.50 – $294.00 = $247.50.

c. No, Jonathan would likely not pursue the purchase of the Industrial Wood Floor Sander. Since the ROI was calculated at 14.73%, this is lower than
what they were able to achieve last year. This decreased percentage would drag down the overall ROI and therefore lead to a less appealing
 evaluation of his section. Had the sander’s ROI been at least 15% that would have been something, Jonathan would have seriously considered in an
effort to continually increase the ROI for his section.

131. The lawn and garden center of a local hardware store would like to find additional ways to
attract customers. One idea the manager of this section had was to purchase a machine that
would allow customers to fill a reusable container of their choosing with grass seed. The
customers would then pay by the ounce and could return to the store as often as needed to
obtain more grass seed. The company also views this as an opportunity to promote a more
earth-friendly approach to lawn center by reducing plastic waste from disposable bags of grass
seed. A new dispenser machine could be purchased and installed at the store for $4,702. There
would be yearly maintenance fee of $186 and other annual expenses (excluding depreciation) of
$563. The machine would have a useful life of 15 years, and the company would like to use a
straight-line depreciation calculation. The manager believes yearly sales would be $1,942. Prior
to moving forward with this purchase, the manager would like to analyze some data. (Do not
round your calculations.)

a. What is the Return on Sales or Profit Margin for the Dispenser? Discuss what this number
means for the company.
b. What is the Investment Turnover for the Dispenser? Discuss what this number means for the
company.
c. Should the manager seriously consider moving forward with this purchase if the ROI is 16% on
average for the company? Would your answer change if the manager’s evaluation was based
upon ROI?
Ans: NA, LO 1, 3, Bloom: E, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution:

a. Profit Margin = 0.4529. Profit margin of 0.4529 means that for every sales dollar, $0.45 is left over as Operating Income.

This question requires familiarity with the formula for Return on Sales or Profit Margin: Operating Income/Sales. First, calculate Operating Income:
Sales – Operating Expenses. The total for Operating Expenses is not provided, so it must be calculated and that will also include a calculation for
depreciation. The company is using the straight-line method for depreciation calculation, so that calculation for annual depreciation is: $4,702/15 years
= $313.47. Operating Expenses = $186 + $563 + $313.47 = $1,062.47. Now, calculate Operating Income: $1,942 – $1,062.47 = $879.53. Lastly,
calculate Profit Margin: $879.53/$1,942 = 0.4529.

b. Investment Turnover = 0.4130. An investment turnover of 0.4130 means that the investment generates around 41% of its value in sales per year.

This question requires familiarity with the formula for Investment Turnover: Sales/Investment. So, Investment Turnover = $1,942/$4,702 = 0.4130.

c. In order to compare the ROI figures, calculate the ROI for this potential investment. This can be done by multiplying profit margin by investment
turnover. 0.4529 × 0.4130 = 0.1871 or 18.71%. The manager should seriously consider the purchase of this dispenser since the ROI it achieves of
18.71% is higher than the company’s normal ROI of 16%. A purchase like this one would serve to increase the overall return that the company sees by
increasing the overall average return. In this instance, the answer would not change if the manager’s evaluation was based on ROI, but the decision
would be reinforced. If the ROI of the dispenser had been below 16%, then this would likely lead the manager to not pursue the purchase since the ROI
would be lower than the company’s past average.

132. Sharon is the lead salesperson for U-Link, a telecommunications company. The company has
been looking into ways that it can become more secure. One of the big decisions being
considered by management is addressing the current security system they have in place at their
corporate headquarters. In doing so, U-Link can expand its offerings to include on-site data
storage. Sharon has narrowed the choices down to either fixing the existing system (Repair) or
purchasing a replacement system (Replace). She has gathered pertinent information to perform
some analysis:

Repair Replace
Cost $12,945 $15,774
Useful Life 8 years 10 years
Sales $ 5,334 $ 6,782
 Operating Expenses (does not include depreciation) $ 3,002 $ 3,898

U-Link has been in business for a number of years and knows that something must change in
order for their business to continue to grow. U-link has a Required Rate of Return of 8.2%, has
a Weighted Average Cost of Capital (WACC) of 6.4%, a tax rate of 21%, and will use the
straight-line depreciation method.
(Do not round your calculations.)

a. What is the Return on Investment (ROI) for each option? Which would be the better choice if the
decision was based upon ROI only?
b. What is the Residual Income of each option? What is the Economic Value Added (EVA) of each
option?
c. Based upon all the percentages generated, how can all of this data be interpreted? Which
choice is the better option for U-Link?
Ans: NA, LO 1, 3, Bloom: E, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution:

a. For Repair, the ROI is 5.51%, and for Replace the ROI is 8.28%.
If ROI were the only determining factor, then Replace would be the better choice. Not only does it result in a higher return than the repair, but it is also
the only option that surpasses the company Required Rate of Return of 8.2%.

These questions require familiarity with the formula for ROI: Operating Income/Investment. Both choices need to update their operating expenses to
include depreciation expense prior to calculating Operating Income and ROI.
Repair: Depreciation expense = $12,945/8 years = $1,618.13 per year. Operating Expenses = $3,002 + $1,618.13 = $4,620.13. Operating Income =
$5,334 – $4,620.13 = $713.88. Thus, ROI = $713.88/$12,945 = 0.0551 or 5.51%.
Replace: Depreciation expense = $15,774/10 years = $1,577.40 per year. Operating expenses = $3,898 + $1,577.40 = $5,475.40. Operating Income =
$6,782 – $5,475.40 = $1,306.60. ROI = $1,306.60/$15,774 = 0.0828 or 8.28%.

b. For Repair, the RI is ($347.62), and for Replace, the RI is $13.13;

For Repair, the EVA is ($264.52), and for Replace, the EVA is $22.68.
These questions require familiarity with the formulas for Residual Income (RI): Operating Income – (Required Rate of Return × Investment), and EVA:
After-Tax Operating Income – (WACC × Investment). Use figures calculated in parts a and b to assist with parts b and c of this exercise.
Repair: Residual Income = $713.88 – (0.082 × $12,945) = $713.88 – $1,061.49 = –$347.62. EVA = ($713.88 × (1 – 0.21)) – (0.064 × $12,945) =
$563.96 – $828.48 = –$264.52.
Replace: Residual Income = $1,306.60 – (0.082 × $15,774) = $1,306.60 – $1,293.47 = $13.13. EVA = ($1,306.60 × (1 – 0.21)) – (0.064 × $15,774) =
$1,032.21 – $1,009.54 = $22.68.

c. Each of the percentages and numbers calculated informs a different component of the overall picture for each investment. If they chose to repair, then
they would not meet their minimum required rate of return, and that means that U-Link should not make the investment. Further, for Repair, both the RI
and the EVA are negative, and that means that Repair will cost the company more than it will recoup or earn. Replace, on the other hand, has an ROI
that exceeds the company required rate of return, so U-Link should make the investment. Both RI and EVA are positive, and that means the investment
is outperforming the base targets set.
Replace would be the better choice for U-Link.

133. Tom and Jerry are both managers of sales teams at Journey Corp., a furniture company
whose most popular item is a tweed couch. Tom and Jerry are very competitive and each
attempt to outperform one another every year. Currently, Tom’s department has better metrics,
which has resulted in larger bonuses for Tom and his team. Journey Corp. evaluates both
departments based upon their Return on Investment and Economic Value Added. The
departments reported the following financial data during the most recent year:

Jerry Tom
Operating Income $126,700 $184,320
Sales $2,789,400 $3,678,005
Average Operating Assets $953,762 $1,320,991
Total Assets $1,103,782 $1,521,001
Current Liabilities $208,630 $296,755
 It should be noted that Journey uses average operating assets as its definition of investment,
and it has a minimum required rate of return of 8.72% and a tax rate of 22%. Journey has used
a variety of ways to acquire capital and has the current makeup: Proportion of Equity is 38%,
the Equity Rate is 6.5%, the Proportion of Debt is 62%, and the Debt rate is 9.3%. Use this
information to answer the following questions.
(Do not round intermediate calculations.)

a. Based upon all of the information provided about Journey Corp, Tom, and Jerry, what type of
responsibility center is run by each manager? Why do you believe this to be true, and what
evidence exists to support your conclusion?
b. What are the Return on Sales, Investment Turnover, and Return on Investment for each
department? Note which department has performed better for each calculation.
c. Determine the Weighted Average Cost of Capital, Residual Income, and Economic Value Added
(EVA) for each department? Overall, which department had the best performance?
Ans: NA, LO 1, 2, 3, Bloom: E, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution:

a. Tom and Jerry are each running an investment center. Since it is noted that each is evaluated on ROI and EVA, this is a hallmark evaluation of an
investment center. If a manager has authority, responsibility, and accountability for their department or division’s asset, then ROI would be an
appropriate way to evaluate them. Other types of responsibility centers rely on metrics like sales targets or target profit but are not focused on
investments. In this question, Tom and Jerry are charged with investment decisions and are judged on these metrics, so this would be the more
appropriate way in which to classify them.

b. Return on Sales for Jerry is 4.54%, and for Tom is 5.01%, so Tom has the better Return on Sales.
Investment Turnover for Jerry is 2.92 times, and for Tom is 2.78 times, so Jerry has the better Investment Turnover.
ROI for Jerry is 13.28%, and for Tom is 13.95%, so Tom has the better Return on Investment.

Return on Sales = Operating Income/Sales

For Jerry: $126,700/$2,789,400 = 0.0454 or 4.54%

For Tom: $184,320/$3,678,005 = 0.0501 or 5.01%

Investment Turnover = Sales/Investment*

*Investment for this company will be Average operating assets.

For Jerry: $2,789,400/$953,762 = 2.92 times

For Tom: $3,678,005/$1,320,991 = 2.78 times

Return on Investment = The formula for ROI is Profit Margin × Investment Turnover. Profit Margin = Operating Income/Sales. Investment Turnover =
Sales/Investment

For Jerry: First, calculate Profit Margin. $126,700/$2,789,400 = 0.0454. Next, calculate Investment Turnover. $2,789,400/$953,762 = 2.925. Lastly,
calculate ROI. ROI = 0.0454 × 2.925 = .1328 or 13.28%.

For Tom: First, calculate Profit Margin as $184,320/$3,678,005 = 0.0501. Next, calculate Investment Turnover as $3,678,005/$1,320,991= 2.784.
Lastly, calculate ROI as 0.0501 × 2.784 = 0.1395 or 13.95%.

c. WACC = 8.24%
Residual Income for Jerry is $43,531.95, and for Tom is $69,129.58, so Tom’s department has a higher Residual Income.
EVA for Jerry is $20,274.16, and for Tom is $34,972.78, so Tom’s department has a higher EVA.
Overall, Tom’s department had the best overall performance during the year based on these metrics.

Weighted Average Cost of Capital (WACC): The WACC is calculated with the following formula: (Cost of Debt × Proportion of Capital Financed with
Debt) + (Cost of Equity × Proportion of Capital Financed with Equity) = (0.093 × 0.62) + (0.065 × 0.38) = 0.0577 + 0.0247 = 0.0824 or 8.24%.

Residual Income is Operating Income – (Minimum Required Rate of Return × Investment)

For Jerry: $126,700 – (0.0872 × $953,762) = $126,700 – $83,168.05 = $43,531.95

For Tom: $184,320 - (0.0872 × $1,320,991) = $184,320 – $115,190.42 = $69,129.58

EVA is After-Tax Operating Income – (WACC × Invested Capital)

For Jerry: ($126,700 × (1 – 0.22)) – (0.0824 × $953,762) = $98,826 – $78,551.84 = $20,274.16

For Tom: ($184,320 × (1 – 0.22)) – (0.0824 × $1,320,991) = $143,769.60 – $108,796.82 = $34,972.78

Overall, Tom’s department had the best overall performance during the year based upon these metrics.
134. Montana oversees the Coffee Bean Division at the Java Corp., and she is evaluating different
options for the sale of their beans. In the past, the Coffee Bean Division has been selling to
external customers only, and has been operating at full capacity. As the business grew and
expanded, so did their production capacity. They are now operating with some idle capacity, and
they have been debating whether to sell internally to another Business Unit. The Coffee Maker
Division has recently decided that they will be giving away a free pound of coffee with each
brewer machine purchase. They anticipate needing 12,500 pounds of coffee in the coming year
and are obtaining quotes both internally and externally. The Coffee Bean Division has a capacity
of 175,000 pounds of coffee and reported the following for their external sales: 160,000 pounds
resulting in sales of $200,000, Variable Costs of $126,400, and Fixed Costs of $51,980. An
external vendor has offered the Coffee Maker Division the following prices: $1.40 for the first
5,000 pounds, $1.20 for the next 5,000 pounds, $1.00 for any number of pounds above this,
with an additional markup of 5% of the total. The Coffee Maker Division is evaluating their
choices, and Montana is hopeful they will have the most appealing offer.

a. What is the minimum acceptable transfer price for their internal purchase from the Coffee Bean
Division? What is the overall price that would be quoted?
b. What is the overall price offered by the external supplier to the Coffee Maker Division?
c. Which offer should the Coffee Maker Division pursue? Are there any additional avenues they
could pursue if they would prefer to go with the alternate vendor?
Ans: NA, LO 4, Bloom: AN, Difficulty: Medium, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution:

a. The minimum acceptable transfer price is $0.79 per pound, and the overall price quoted is $9,875.

This question requires determination of what amounts would factor into the minimum acceptable transfer price. Since the Coffee Bean Division is not
currently operating at capacity, this would mean that internal buyers, such as the Coffee Maker Division, must pay the variable cost per unit on external
sales. Variable cost per unit = $126,400/160,000 pounds = $0.79 per pound, and that is the minimum acceptable transfer price.
The overall price quoted by the Coffee Bean Division would be $0.79 × 12,500 pounds = $9,875.

b. The overall price quoted from the external supplier is $16,275

The overall price offer to the Coffee Maker Division by the external supplier has to be calculated in layers. The first 5,000 pounds sold will be $1.40 per
pound, the next 5,000 pounds will be $1.20 per pound, and the remaining 2,500 pounds will sold at be $1.00 per pound. (5,000 × $1.40) + (5,000 ×
$1.20) + (2,500 × $1.00) = $7,000 + $6,000 + $2,500 = $15,500. The final step is to add the 5% markup to that total: $15,500 × 1.05 = $16,275.

c. If the Coffee Maker is basing their decision solely on price, then they would select the internal division’s offer from the Coffee Bean Division. They may
also want to consider the benefits of working within the same organization rather than purchasing from an external vendor. If they would prefer to use
the external vendor, then they may want to consider asking them to negotiate their first offer. This could involve a change in the prices being asked, the
removal of the markup, or some combination of these things. Additionally, the Coffee Maker Division could continue to seek other offers and options
from more external vendors for further analysis and comparison.

135. Karen owns a small company that has several business units. The main product of this
company is jackets sewn with a special insulated lining that can withstand extremely cold
temperatures. One of her business units at the company is responsible for the production of the
fancy decorative buttons sewn onto the front of this jacket. The button division has the capacity
to meet both internal and external demand with an overall production capacity of 15,000 buttons
annually. The company manufactured and sold 12,479 of its available units to the external
companies. The Jacket Division just lost its main external button supplier and is in need of 8,788
buttons as soon as possible. The Jacket Division has been collecting external bids but has also
requested that the Button Division provide a quote prior to making a final decision. The Button
Division has produced the following numbers so far (all based upon sales to external
customers):
Sales $10,798
Variable
Costs $ 4,675
 Fixed Costs $ 4,227
The jacket division has been given the following offers from external suppliers
Supplier A: $1.09 per button plus a 2% markup to cover shipping
Supplier B: $1.14 per button plus a $250 total shipping rate

a. What is the minimum acceptable transfer price for their internal purchase from the Button
Division? What is the overall price they would need to pay for these buttons?
b. What is the overall price for Supplier A? What is the overall price for Supplier B? Which supplier
has created the more appealing offer?
c. Since the jacket division needs these buttons quickly, what option should they select? Would
your answer change if Supplier A and Supplier B both waived their shipping charges?
Ans: NA, LO 4, Bloom: E, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution:

a. The minimum acceptable transfer price: idle capacity = $0.37 per button and no idle capacity = $0.86; therefore, the overall price is $6,322.39.

This problem requires familiarity with the formula for the minimum acceptable transfer price when a factory has both idle capacity and when it has no
idle capacity. This will result in two different minimum acceptable transfer prices. To determine how many are subject to each price, subtract the current
production from the high threshold of the capacity. 15,000 – 12,479 = 2,521 buttons can still be produced using existing idle capacity. The minimum
acceptable transfer price of these 2,521 buttons is the variable cost per unit, and that is equal to $4,675/12,479 buttons = $0.37 per button. The
number of units charged at a different price other than the variable cost will be the total requested units minus the units able to be made before hitting
capacity = 8,788 – 2,521 = 6,267 buttons. The minimum acceptable transfer price of these remaining 6,267 buttons will be the variable manufacturing
cost per unit plus contribution margin per unit on external sales. Contribution margin = Sales – Variable Costs = $10,798 – $4,675 = $6,123. Now,
divide this by the units sold externally: $6,123/12,479 buttons = $0.49 per button. The minimum acceptable transfer price = $0.37 + $0.49 = $0.86 per
button. The total price that will be quoted is: (2,521 × $0.37) + (6,267 × $0.86) = $932.77 + $5,389.62 = $6,322.39.

b. Supplier A = $9,770.50, Supplier B = $10,268.32. Supplier A has created a more appealing offer between these two external vendors since their overall
price is much lower even after the 2% markup

Supplier A = 8,788 buttons times $1.09 per button plus a 2% markup. (8,788 × $1.09) × 1.02 = $9,578.92 × 1.02 = $9,770.50.
Supplier B = 8,788 buttons times $1.14 per button plus a $250 shipping fee. (8,788 × $1.14) + $250 = $10,018.32 + $250 = $10,268.32.

c. Since the Jacket Division is in a hurry and must decide quickly, they are likely to select the offer from the Internal Button Division, assuming they can
receive their order as soon as possible. If the Button Division is not able to deliver the buttons in an acceptable time frame, then the Jacket Division
would then look more seriously at the offer from Supplier A. Even if Supplier A and Supplier B dropped their shipping surcharges, the internal Button
Division would still offer a better price than either Supplier A or Supplier B. However, should the Button Division fall through, then the lack of shipping
charges would make the offer from Supplier A more appealing than that quoted by Supplier B as the overall price would then be lower.

136. The Fizzy Drink Company is a large factory that produces soft drinks in a variety of flavors.
Recently the Diet Drink division has been increasing production and is looking to obtain pricing
on materials from a variety of vendors, both internally and externally for their bottling needs.
Supplier A offered to sell them bottles for $0.80 per bottle for the first 10,000, $0.78 for the next
10,000 bottles, $0.76 for the next 15,000, and $0.73 for any remaining bottles. Supplier B
offered to sell them bottles for $0.75 for the first 50,000 bottles and $0.74 for any remaining
bottles. Supplier A is going to add 2% surcharge for shipping and handling costs, and Supplier B
is going to add a 1.5% surcharge for shipping and handling costs. The Diet Drink division has
also put in an inquiry with their internal Bottle division who currently has a capacity of 233,600
bottles, leaving some capacity idle. They have reported the following numbers for the year:
Sales (200,000 bottles) $223,780
Direct Labor $52,000
Direct Material $30,000
Variable Overhead $24,000
Fixed Overhead $38,000

The Diet Drink division is looking to order 76,430 bottles and will need to perform an analysis
before making a final decision.
(Do not round intermediate calculations.)
a. What is the variable cost, contribution margin, and absorption cost of each unit sold by the
Bottle Division? What is the minimum acceptable transfer price if the internal Bottle division
agrees to supply required bottles to the Diet Drink division?
b. What are the overall prices quoted by Supplier A and Supplier B for 76,430 bottles?
c. What is the overall price quoted by the Internal Bottle Division? Which offer is the Diet Division
most likely to pursue, and why? Support your conclusion.
Ans: NA, LO 4, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution:

a. Variable Cost per unit is $0.53, Contribution Margin per unit is $0.59, Absorption Cost per unit is $0.72,
Minimum acceptable transfer price for Idle capacity units is $0.53 per bottle, and no idle capacity units is $1.12 per bottle.

The variable cost per unit will be equal to the variable costs for units sold externally divided by the units sold externally. (Direct Labor + Direct Materials
+ Variable Overhead)/Units Sold Externally. ($52,000 + $30,000 + $24,000)/200,000 bottles = $0.53 per bottle. Contribution Margin per Unit will equal:
(Sales made externally – Variable Costs)/Units sold externally. ($223,780 – ($52,000 + $30,000 + $24,000))/200,000 bottles = ($223,780 –
$106,000)/200,000 bottles = $117,780/200,000 bottles = $0.59 per bottle. Absorption cost per unit will equal: (Variable Costs + Fixed Costs)/Units sold
externally. [($52,000 + $30,000 + $24,000) + $38,000]/200,000 bottles = ($106,000 + $38,000)/200,000 bottles = $144,000/200,000 bottles = $0.72 per
bottle. The minimum acceptable transfer price will have two different prices assigned: one for units produced with idle capacity and one for units
produced with no idle capacity. Minimum transfer price in idle capacity will equal to variable cost per unit calculated above at $0.53 per bottle. Minimum
transfer price when there is no idle capacity will be equal to the variable cost per unit plus the contribution margin per unit = $0.53 per bottle + $0.59
per bottle = $1.12 per bottle.

b. Overall Price for Supplier A is $58,592.78 and for Supplier B is $57,914.07.

Supplier A: The overall price offer to the Diet Drink division by Supplier A has to be calculated in layers. The first 10,000 bottles sold will be $0.80 per
bottle, the next 10,000 bottles will be $0.78 per bottle, the next 15,000 bottles will be $0.76 per bottle, and the remaining bottles will be $0.73 per bottle.
(10,000 × $0.8) + (10,000 × $0.78) + (15,000 × $0.76) + ((76,430 – 35,000) × $0.73) = $8,000 + $7,800 + $11,400 + $30,243.90 = $57,443.90. The last
step will be to add the 2% surcharge: $57,443.90 × 1.02 = $58,592.78.

Supplier B: The overall price offer to the Diet Drink division by Supplier B has to be calculated in layers. The first 50,000 bottles sold at $0.75 per bottle
and the remaining bottles at $0.74 per bottle. (50,000 × $0.75) + ((76,430 – 50,000) × $0.74) = $37,500 + $19,558.2 = $57,058.2. The last step will be
to add the 1.5% surcharge: $57,058.2 × 1.015 = $57,914.07.

c. With an overall price of $65,777.60, they are more likely to pursue the offer from Supplier A.

The overall price quoted by the internal division has to be calculated in layers- No idle capacity and idle capacity. Idle capacity units = 233,600 –
200,000 = 33,600 units. These units will have the minimum acceptable transfer price calculated in part a) of $0.53 per bottle, which is the variable cost
per unit. The remaining units will be calculated as no idle capacity units = 76,430 – 33,600 = 42,830 units. These units will have the minimum
acceptable transfer price calculated in part a) of $1.12 per bottle. Overall price = (33,600 × $0.53) + (42,830 × $1.12) = $17,808.00 + $47,922.49 =
$65,730.49.
The Diet Drink division is likely to pursue the offer from Supplier B as it has the lowest overall cost as supported by the calculations above and what is
shown in part b). They could also ask Supplier B to drop their 1.5% surcharge to make that offer more competitive. Lastly, they could try to negotiate
further with the internal division, using the external supplier quotes as leverage to attempt a lower quote.

137. Ingen Production manufactures a top-of-the-line record player, and the Needle division
manufactures one of many of the components needed to create the final product. The Needle
division has an overall capacity of 150,000 units, which covers all internal needs and leaves
enough capacity to sell directly to the external market. Thanks to proper planning, the Needle
division has been able to successfully meet all of its production orders, both internally and
externally. Ingen evaluates its management on the profitability of their respective divisions, so
the managers are very interested in performing analysis on a regular basis. The manager of the
Needle division has determined the following costs to be associated with the production of one
needle (unit):

Direct Material $0.50

Direct Labor $0.89
Variable-MOH $0.46
Fixed-MOH $1.15

The manager of the Record Player division mentioned that they can purchase needles
externally for $3.70. Use this information to answer the following questions.
a. If the Needle Division sets the transfer price at $3.30, then would this be a good deal for both
the Needle division and the Record Player division? Does this transfer price reflect variable cost,
absorption cost, cost plus, market, or a cost of a different kind?
b. If the market price were to drop to $2.90, then would this still be a deal that the Needle division
would find beneficial? Would they keep the same transfer price established in part a) or would
they calculate a new one? Support your response with the appropriate calculations.
c. Assume the market continues to decrease in price. What is the lowest acceptable transfer price
that the Needle division could accept? If this came to fruition, then what other measures could
the Needle division take in order to try and increase their revenue or reduce their other costs?
Ans: NA, LO 1, 4, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution:

a. Prior to determining whether or not this is a good deal, it would be beneficial to calculate how much of the costs that $3.30 would cover. The overall
costs incurred by the Needle division to produce one unit are: $0.50 + $0.89 + $0.46 + $1.15 = $3.00. At the transfer price of $3.30, this would be a
good deal for the Needle division since they are not only covering the full absorption cost but also earning an extra $0.30 per unit sold internally. This is
also a good deal for the Record Player division since they are paying $0.40 less per needle than they would be by purchasing the needles externally.

b. If the market price dropped to $2.90, then this would still cover most of the costs incurred by the Needle division. With the new market price being lower
than the transfer price established in part (a), they would not keep the transfer price of $3.30 and would have to establish a new one. Their variable
costs are: $0.50 + $0.89 + $0.46 = $1.85. The new market price would cover all of the variable costs while also adding an extra $1.05 in revenue per
needle that would almost cover the full absorption cost. The new transfer price could now be in a range from $1.85 at the low end up to $2.90 at the
high end per unit. Anything less than $2.90 is likely to be enticing for the Record Player division as it is still less than they would have to pay if they
were purchasing externally.

c. If the market continues to decrease in price, then they would have to adjust their minimum acceptable transfer price as well. The lowest they would be
able to accept would be their variable cost: $0.50 + $0.89 + $0.46 = $1.85. If the market price eventually dropped below $1.85, then this would present
a difficult challenge for the Needle division. In order to increase revenues, they would have to seek out additional vendors that would want or need their
product. To reduce their variable costs, they could also seek out a reduction in their direct materials cost if they were able to negotiate this with the
supplier they buy from.

138. Spiral Company is a pasta company that specializes in fun-shaped pasta specifically marketed
towards kids. Currently, they manufacture all of their pasta internally and purchase boxes from
an external vendor for $0.58 per box. Carol, the manager of the Pasta department has big
decisions to make for her department for the New Year as she creates a budget. One of their
largest pasta-cutting machines will need to be replaced, and she finally found a great vendor
who has offered to sell them a new model for $14,600. Carol has calculated the following
estimates for the new machine:
Expected Sales (2,578 units) $3,428
Expected Operating Expenses (including depreciation) 2,040

Each unit contains 16 ounces of pasta and requires one cardboard box in which it will be
packaged and shipped. Carol has also been speaking with their internal packaging department
about purchasing boxes from them. The manager of that department is going to put together a
sales quote and has gathered the following information about their sales for the year:
Sales (7,000 units) $3,920
Variable Expenses $1,540
Fixed Costs $1,904
Operating Capacity 7,000 units

The negotiated price will be the minimum acceptable transfer cost. Spiral Company has a tax
rate of 25%, a weighted average cost of capital of 6.6%, and a minimum required rate of return
of 8.1%. Use the above information to answer the following questions.

a. What is the Return on Investment and Economic Value Added from the new machine? If
repairing the existing machine would also cost $14,600 but it had no Economic Value Added,
then which deal should Carol select?
b. What is the per-unit minimum acceptable transfer price and overall price quoted by the internal
packaging department? Calculate the percentage difference between the quotes from the
internal packaging department and the external vendor?
c. Which offer will Carol select for her department? What is the highest amount Carol should be
willing to pay internally per unit before she should consider it to be a bad decision?
Ans: NA, LO 1, 2, 3, 4, Bloom: AN, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning,
& Performance: Decision Analysis. Solution:

a. Return on investment is 9.51%, and economic value added is $77.40, so Carol should select the new machine.

ROI-This question requires familiarity with the formula for ROI which is Operating Income/Investment: $1,388/$14,600 = 0.0951 or 9.51%.

EVA-This question requires familiarity with the formula for EVA which is After-Tax Operating Income – (WACC × Invested capital): ($1,388 × (1 – 0.25))
– (0.066 × $14,600) = $1,041.00 – $963.60 = $77.40.

Carol would likely select the new machine as it does have a positive economic value added. The repair of the new machine is the same cost but adds
nothing else, so it is a less appealing deal.

b. The minimum acceptable transfer price is $0.56 per box, and the internal price quote = $1,443.68. The external vendor’s quote is 3.6% higher than that
of the internal department.

This question requires determination of the amounts would factor into the minimum acceptable transfer price. Since Spiral Company is currently
operating at capacity and has no idle capacity, this would mean that any internal buyers, including the Pasta department, must pay the equivalent of
the market price, and that is variable cost per unit plus the contribution margin per unit on external sales. To solve for the contribution margin, subtract
the variable costs from the sales and divide by the number of units sold externally. ($3,920 – $1,540)/7,000 boxes = $2,380/7,000 boxes = $0.34
contribution margin per box. Variable cost per unit = $1,540/7,000 boxes = $0.22 per box. Minimum acceptable transfer price = $0.34 + $0.22 = $0.56
per box.

The overall price quote from the internal vendor will equal the negotiated price (the minimum acceptable transfer price) times the number of units to be
purchased. $0.56 × 2,578 boxes = $1,443.68.

To calculate the difference in quotes, calculate the quote from the external vendor which is $0.58 per box. $0.58 × 2,578 boxes = $1,495.24. The
percentage difference can be calculated using horizontal analysis. ($1,495.24 – $1,443.68)/$1,443.68 = 0.0357 or 3.57% higher with the external
vendor.

Carol has had a productive round of analysis and has found some interesting information. Based on the analysis she performed, Carol is likely to move
forward with purchasing the new machine and to purchase the boxes needed for packaging from their internal department. Carol would likely be willing
to pay at most $0.58 per box, which is the current quoted price by the external vendor. Any price above this would be considered a counter-productive
decision and should lead Carol to select an external vendor.

Problem

139. Comfy Critters is a factory that creates stylish and comfortable bedding for dogs of all sizes.
They are entering their 6th year of business, and they have decided that one of their largest
sewing machines is nearing the end of its useful life. Their production manager, Todd, is trying
to help management decide how best to proceed with their next steps. Todd has the choices
narrowed down to repairing the current machine (Repair), or replacing the machine with one of
two different replacement options (New Machine 1 or New Machine 2). The numbers associated
with each of these options are as follows:

Repair New Machine 1 New Machine 2

Cost $8,876 $14,268 $16,155
Useful Life 8 years 10 years 11 years
Sales $7,423 $13,964 $15,897
Operating Expenses (does not
include depreciation) $6,163 $10,402 $12,705

The company has chosen to utilize the straight-line method of depreciation calculation. The
company has utilized a variety means to raise capital, and it is allocated as follows:
 Cost of Debt 5.3%
Proportion of Debt 73.0%
Cost of Equity 7.2%
Proportion of Equity 27.0%

Comfy Critters has a tax rate of 25% and a Required Rate of Return of 8.4%.
(Do not round your calculations.)
a. What is the Weighted Average Cost of Capital (WACC) for Comfy Critters?
b. What are the Return on Investment (ROI), Residual Income (RI), and Economic Value Added
(EVA) for the Repair option?
c. What are the Return on Investment, Residual Income, and Economic Value Added for the New
Machine 1 option?
d. What are the Return on Investment, Residual Income, and Economic Value Added for the New
Machine 2 option?
e. What should Todd recommend to management based on the analyses in parts b, c, and d?
Provide as much detail as possible to support that decision.
Ans: NA, LO 1, 2, 3, Bloom: E, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution:

a. WACC = 5.81%

This question requires familiarity with the formula for WACC. This formula will be used to determine other figures as well. WACC = (Cost of Debt ×
Proportion of Capital Financed with Debt) + (Cost of Equity × Proportion of Capital Financed with Equity). WACC = (0.053 × 0.73) + (0.072 × 0.27) =
0.0387 + 0.0194 = 0.0581 or 5.81%.

b. For Repair: ROI = 1.70%, RI = ($595.08), and EVA = ($403.09)

This question requires familiarity with three different formulas: ROI, which is Operating Income divided by Investment; RI, which is Operating Income –
(Required Rate of Return × Investment); and EVA, which is After-Tax Operating Income – (WACC × Investment). First, Operating Income must be
calculated, and that also includes updating operating expenses to include the depreciation expenses. $8,876/8 years = $1,109.50. Operating Income =
$7,423.00 – ($6,163.00 + $1,109.50) = $7,423.00 – $7,272.50 = $150.50. Now, calculate the ROI: ($150.50/$8,876.00) = 0.0170 or 1.70%; RI: $150.50
– (0.084 × $8,876.00) = $150.50 – $745.58 = –$595.08; and EVA: ($150.50 × (1 – 0.25)) – (0.0581 × $8,876.00) = $112.88 – $515.96 = –$403.09.

c. For New Machine 1: ROI = 14.96%, RI = $936.69, and EVA = $772

This question requires familiarity with three different formulas: ROI, which is Operating Income divided by Investment; RI, which is Operating Income –
(Required Rate of Return × Investment); and EVA, which is After-Tax Operating Income – (WACC × Investment). First, Operating Income must be
calculated, and that also includes updating operating expenses to include the depreciation expenses. $14,268/10 years = $1,426.80. Operating Income
= $13,964.00 – ($10,402.00 + $1,426.80) = $13,964.00 – $11,828.80 = $2,135.20. Now, calculate the ROI: $2,135.20/$14,268.00 = 0.1496 or 14.96%;
RI: $2,135.20 – (0.084 × $14,268.00) = $2,135.20 – $1,198.51 = $936.69; and EVA: ($2,135.20 × (1 – 0.25)) – (0.0581 × $14,268.00) = $1,601.40 –
$829.40 = $772.00.

d. For New Machine 2: ROI = 10.67%, RI = $366.34, and EVA = $353.43

This question requires familiarity with three different formulas: ROI, which is Operating Income divided by Investment; RI, which is Operating Income –
(Required Rate of Return × Investment); and EVA, which is After-Tax Operating Income – (WACC × Investment). First, Operating Income must be
calculated, and that also includes updating operating expenses to include the depreciation expenses. $16,155/11 years = $1,468.64. Operating Income
= $15,897.00 – ($12,705.00 + $1,468.64) = $15,897.00 – $14,173.64 = $1,723.36. Now, calculate the ROI: $1,723.36/$16,155.00 = 0.1067 or 10.67%;
RI: $1,723.36 – (0.084 × $16,155.00) = $1,723.36 – $1,357.02 = $366.34; and EVA: ($1,723.36 × (1 – 0.25)) – (0.0581 × $16,155.00) = $1,292.52 –
$939.09 = $353.43.

e. Todd’s analysis has helped management decide which of the three options is best for the company. Repair is not a viable option because it not only
fails to meet the Required Rate of Return for the company of 8.4% but both its RI and EVA are negative. New Machine 2 is the second least likely
option. This option did surpass the company’s Required Rate of Return and produced a positive RI and EVA, but New Machine 1 produced better
numbers in all three categories. New Machine 1 would be the best option to recommend to management as the best performer of the three.

140. Fabulous Fanny Packs Co. has two divisions that are both profit centers: Materials and
Sewing. Fabulous Fanny Packs is known for their luxurious, unique, handmade fanny packs,
which is also its only product. In addition to external vendors, the Materials division sells some
of its fabric to the Sewing division. The Sewing division uses this fabric to create the fanny
packs. Yearly operating income generated from external sales is calculated as follows:

Materials Sewing Division

 Division
Sales $119,600 $207,854
Variable Expenses 85,544 146,59
0
Contribution Margin $34,056 $61,264
Fixed Expenses 25,762 37,868
Operating Income $8,294 $23,396

One yard of fabric is needed to create each fanny pack. Although the fabric is very unique, the
Materials division was able to find an intermediate market where they also sell to external
vendors, as reflected in the numbers above. Their operating capacity is 100,000 yards of fabric
and they sold 76,420 yards to external vendors. The Materials division received an order from
the Sewing division for 20,000 yards of fabric. Fabulous Fanny Packs has been considering
whether or not to vertically integrate further by purchasing a retailer so the Sewing division could
sell their products internally and sell to external vendors. Use all of this information to answer
the following questions.
(Do not round your calculations.)

a. What is the minimum acceptable transfer price for the sale of yards to the Sewing division?
What is the overall price for the yards of fabric being sold to the Sewing division?
b. Now assume the Sewing division had sought external quotes for 20,000 yards of fabric they
needed to purchase and were given a quote of $1.10 per yard plus an additional charge of 2.5%
(of initial price) to cover packaging, shipping, and handling. What would the overall price be for
this quote? What is the percentage difference between this option and the one calculated in part
a)?
c. Which offer should the Sewing division pursue? What factors should be considered when
making this decision, and are there any other things they could do that may impact that decision
one way or the other?
d. Assume that the sewing department was actually looking to purchase 40,000 yards of fabric
from the Materials division. What would the per-unit minimum acceptable transfer price be, and
what would the new overall price be?
e. If the market shifted and the external vendors that the Materials division sells to are now going
to be offered at $1.72 per yard, would this impact either of the responses provided in part a) or
d)? Support this response with the appropriate calculations.
Ans: NA, LO 1, 2, 4, Bloom: E, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution:

a. The minimum acceptable transfer price is $1.12 per yard of fabric, so the overall price quoted is $22,387.86.

This question requires determination of what amounts would factor into the minimum acceptable transfer price. The Materials division has idle capacity,
so this means that the Sewing division would be charged the variable cost per unit on external sales as the minimum acceptable transfer price.
Variable cost per unit = $85,544/76,420 yards = $1.12 per yard, so that is the minimum acceptable transfer price. The overall price quoted by the
Materials division would be $1.12 × 20,000 yards = $22,387.86.

b. The External Price Quote is $22,550; the external vendor’s quote is 0.72% higher than the price quoted by the Materials division.

External Supplier = 20,000 yards times $1.10 per yard plus 2.5% of that in additional charges. (20,000 × $1.10) × 1.025 = $22,000 × 1.025 = $22,550.
To calculate the percentage difference in price, compare the overall quotes from the Materials division and the external vendor. ($22,550 –
$22,387.86)/$22,387.86 = 0.72%. The external vendor’s overall price quote is 0.72% higher than the quote from the Materials division.

c. One of the largest considerations when deciding which offer to pursue will be the overall cost. The Materials division offers the lowest overall price, and
they will likely be the most appealing offer for the Sewing division.
Other things that may factor in could be the convenience of using a department that is vertically integrated within the company and a quicker
turnaround time on order fulfillment. The Sewing division could also attempt to negotiate with the external vendor and ask them to reduce their per-yard
cost or to waive the 2.5% additional charges. Doing the latter would reduce the overall price to $22,000, and that is lower than the overall price quoted
from the Materials Division.
d. Minimum acceptable transfer price while using idle capacity is $1.12 per yard, and when there is no idle capacity is $1.57; so, the overall price is
$52,093.16.

If the Sewing division is now looking to purchase 40,000 yards, this would stretch beyond the capacity that the Materials division has. This problem
requires familiarity with the formula for the minimum acceptable transfer price when a factory has both idle capacity and when it has no idle capacity.
This will result in two different minimum acceptable transfer prices. To determine how many are subject to each price, subtract the current production
from the high threshold of the capacity. 100,000 – 76,420 = 23,580 yards can still be produced before hitting capacity. The minimum acceptable
transfer price of 23,580 yards will be equal to the variable cost per unit, which is equal to $85,544/76,420 yards = $1.12 per yard. The number of units
that will be charged at a different price other than the variable cost will be the total requested units minus the units below capacity = 40,000 – 23,580 =
16,420 yards. The minimum acceptable transfer price of 16,420 yards will be the variable manufacturing cost per unit plus contribution margin per unit
on external sales. Contribution margin = Sales – Variable Costs = $119,600 – $85,544 = $34,056. Now, divide this by the units sold externally:
$34,056/76,420 yards = $0.45 per yard. The minimum acceptable transfer price is $1.12 + $0.45 = $1.57 per yard. The total price that will be quoted is:
(23,580 × $1.12) + (16,420 × $1.57) = $26,395.28 + $25,697.88 = $52,093.16.

e. If the market price shifted to $1.72 per yard, then this would affect the overall sales generated by the Materials division in addition to the contribution
margin. In part (a), there was idle capacity, and that meant that the minimum transfer price on their sale to the Sewing division would be the variable
cost per unit. The change in sales price to the external vendors would not affect or impact the price quote in part (a). The answer to part (d) would be
impacted, though. The quote for work done when there is no idle capacity will change. First, recalculate sales and the contribution margin. 76,420 yards
sold × $1.72 per yard = $131,442.40. The new contribution margin will equal sales minus variable costs = $131,442.40 – $85,544 = $45,898.40. New
minimum transfer price = ($85,544/76,420 yards) + ($45,898.40/76,420 yards) = $1.12 + $0.60 = $1.72 (the same as the per unit sales price). Now,
recalculate the overall price quote with the new figure. (23,580 × $1.12) + (16,420 × $1.72) = $26,395.28 + $28,242.40 = $54,637.68. This price is
($54,637.68 – $52,093.16) which is $2,544.52 more than it was before the external price increase.

141. Sandra has had a very busy year as the production manager for the Patio Chair Department
for Younique Patio Designs, Inc. In addition to expanding into new markets, Sandra has been
working with the design team to bring her dream of adding a wicker patio chair to their current
list of offerings. The design team has provided a list of requirements that must be met in order to
be able to produce the chairs, including a machine that will enable assembly workers to cut and
weave the wicker material. After speaking with several vendors, Sandra was given the following
quotes:
Machine A: $50,500 (10-year useful life)
Machine B: $44,600 (9-year useful life)
Machine C: $43,420 (8-year useful life)
Younique would use straight-line depreciation for their calculations. She used this information
and her own data to assemble the following predictions:
Machine A Machine B Machine C
Sales $17,423 $23,964 $25,897
Operating Expenses $ 4,663 $10,402 $12,705
(not including depreciation)

Cost of Equity 8.10%

Proportion of Equity 23%
Cost of Debt 5.7%
Proportion of Debt 77%
Income tax rate 24%
Required rate of return 8.3%

Sandra has the option to purchase the wicker material from an external vendor for $2.16 per
sheet with a 5% surcharge to deliver the sheets. Each chair will need 1 sheet of wicker to be
completed. Younique wants to purchase 16,783 sheets of wicker to meet their production
projections. They could also get the supply from Younique’s internal Materials Department.
Their Materials Department has provided the following information about their production:

Sales (external sales of 98,000

sheets) $226,800
Variable Costs 157,42
 0
Fixed Costs 62,340

The Materials Department has a production capacity of 110,000 units so they currently have idle
capacity. Use all of this information to answer the following questions.

(Do not round your calculations.)

a. What are the Profit Margins and Investment Turnovers for Machines A, B, and C?
b. What are the Returns on Investment (ROIs) and Residual Incomes (RIs) for Machines A, B, and
C?
b. What are the Economic Values Added (EVAs) for Machines A, B, and C? What is the
percentage difference between the Machine with the highest EVA and the lowest EVA?
c. What is the minimum acceptable transfer price for using the internal Materials Department for
purchasing the wicker sheets? What is the overall price quoted by this department to the Patio
Chair Division?
d. Which machine will be the best choice for the Patio Chair Department? Which supplier would
provide the best option for them to pursue? Please explain all answers.
Ans: NA, LO 1, 3, 4, Bloom: E, Difficulty: Hard, AACSB: Analytic, AICPA: AC: Measurement, Analysis, and Interpretation, IMA: Strategy, Planning, &
Performance: Decision Analysis. Solution:

a. Machine A: Profit Margin is 0.4425, and Investment Turnover is 0.3450;

Machine B: Profit Margin is 0.3591, and Investment Turnover is 0.5373;
Machine C: Profit Margin is 0.2998, and Investment Turnover is 0.5964

This question requires familiarity with the formulas for Return on Sales (Profit Margin): Operating Income/Sales, and Investment Turnover:
Sales/Investment. First, calculate Operating Income: Sales – Operating Expenses. The total for operating expenses is not provided, so it must be
calculated and that should include a calculation for depreciation.

Machine A: Depreciation = $50,500/10 years = $5,050 per year. Operating Income = $17,423 – $4,663 – $5,050 = $7,710. Profit Margin =
$7,710/$17,423 = 0.4425. Investment Turnover = $17,423/$50,500 = 0.3450.

Machine B: Depreciation = $44,600/9 years = $4,955.56 per year. Operating Income = $23,964 – $10,402 – $4,955.56 = $8,606.44. Profit Margin =
$8,606.44/$23,964 = 0.3591. Investment Turnover = $23,964/$44,600 = 0.5373.

Machine C: Depreciation = $43,420/8 years = $5,427.50 per year. Operating Income = $25,897 – $12,705 – $5,427.50 = $7,764.50. Profit Margin =
$7,764.50/$25,897 = 0.2998. Investment Turnover = $25,897/$43,420 = 0.5964.

b. Machine A: ROI is 0.1527, and RI is $3,518.50;

Machine B: ROI is 0.1930, and RI is $4,904.64;
Machine C: ROI is 0.1788, and RI is $4,160.64

This question requires familiarity with the formula for ROI: Profit Margin × Investment Turnover, and Residual Income: Operating Income – (Required
Rate of Return × Investment). Profit Margin and Investment Turnover were calculated in part (a) for each Machine, so those numbers can be used here
as well.

Machine A: Return on Investment = 0.4425 × 0.3450 = 0.1527. Residual Income = $7,710 – (0.083 × $50,500) = $7,710 – $4,191.50 = $3,518.50.

Machine B: Return on Investment = 0.3591 × 0.5373 = 0.1930. Residual Income = $8,606.44 – (0.083 × $44,600) = $8,606.44 – $3,701.80 =
$4,904.64.
Machine C: Return on Investment = 0.2998 × 0.5964 = 0.1788. Residual Income = $7,764.50 – (0.083 × $43,420) = $7,764.50 – $3,603.86 =
$4,160.64.

c. EVA for Machine A is $2,702.34, EVA for Machine B is $3,752.51, and EVA for Machine C is $3,186.40.
Machine B has an EVA that is 38.86% higher than the EVA of Machine A

These questions require familiarity with the formulas for EVA: After-Tax Operating Income – (WACC × Investment) and for the Weighted Average Cost
of Capital (WACC): (Cost of Debt × proportion of Capital Financed with Debt) + (Cost of Equity × Proportion of Capital Financed with Equity). WACC =
(0.057 × 0.77) + (0.081 × 0.23) = 0.04389 + 0.01863 = 0.06252

Machine A: ($7,710.00 × (1 – 0.24)) – (0.06252 × $50,500) = $5,859.60 – $3,157.26 = $2,702.34.

Machine B: ($8,606.44 × (1 – 0.24)) – (0.06252 × $44,600) = $6,540.90 – $2,788.39 = $3,752.51.

Machine C: ($7,764.50 × (1 – 0.24)) – (0.06252 × $43,420) = $5,901.02 – $2,714.62 = $3,186.40.

The Machine with the highest EVA is Machine B, and the Machine with the lowest EVA is Machine A. Use horizontal analysis to calculate their
percentage difference. The formula would be: (Machine B EVA – Machine A EVA)/Machine A EVA = ($3,752.51 – $2,702.34)/$2,702.34 = 0.3886 or
38.86%.
d. Minimum acceptable transfer price: idle capacity = $1.61, No idle capacity = $2.31; therefore, the overall price = $30,345.15.

This problem requires familiarity with the formula for the minimum acceptable transfer price when a factory has both idle capacity and when it has no
idle capacity. This will result in two different minimum acceptable transfer prices. To determine how many are subject to each price, subtract the current
production from the high threshold of the capacity. 110,000 – 98,000 = 12,000 units can still be produced before hitting capacity. The minimum
acceptable transfer price of those 12,000 wicker sheets will be equal to the variable cost per unit, which is equal to $157,420/98,000 = $1.61 per sheet.
Any sheets produced when there is no idle capacity will have a minimum acceptable transfer price of the variable cost per unit plus the contribution
margin per unit. Contribution margin = Sales – Variable Costs = $226,800 – $157,420 = $69,380. Now, divide this by the units sold externally:
$69,380/98,000 sheets = $0.71 per sheet. The minimum acceptable transfer price = $1.61 + $0.71 = $2.31 per sheet. The number of units that will be
charged at this price will be the total requested minus the units produced before hitting capacity which is 16,783 – 12,000 = 4,783 units. The total price
that will be quoted is: (12,000 × $1.61) + (4,783 × $2.31) = $19,275.92 + $11,069.23 = $30,345.15.

e. The Machine that would be the best choice for Younique to purchase would be Machine B since it had higher ROI, RI, and EVA when compared to the
other two choices. All three Machines would yield positive results for Younique, so Sandra could comfortably suggest any of them. Should Machine B
not work out, then her next likely suggestion would be Machine C since it produced the second highest results.

Before deciding what supplier they select, calculate the overall price offered by the external vendor. They want $2.16 per sheet with a 5% surcharge to
cover shipping. (16,783 sheets × $2.16 per sheet) × 1.05 = $36,251.28 × 1.05 = $38,063.84. At this price, it would make the most sense for Younique
to select their internal Materials Department as the overall price they would be obligated to pay is ($38,063.84 – $30,345.15) = $7,718.70 less.