Question

Goodstone Tires designs, manufactures, and sells automotive tires through three profit centers (divisions): Passenger Vehicles, Industrial Vehicles, and Racing. The Racing Division develops state- of-the- art high- performance racing tires for NASCAR, grand prix, and Indy cars. Racing, while a small part of Goodstone’s total revenues and profits, provides much external visibility and a proving ground for Goodstone’s future generation of passenger and industrial tires. Racing’s motto is “What’s winning today is on tomorrow’s cars and trucks.” The following table summarizes the revenues and variable and fixed expenses (in millions of dollars) of the three divisions:



Each division operates as a decentralized organization with its own manufacturing, distribution, marketing, administrative, and sales organizations. Corporate headquarter costs of $ 1,400 million are allocated to the three divisions based on divisional sales.

Required:
a. Prepare a report detailing divisional performance based on net income after allocating corporate overhead using divisional sales as the allocation base.
b. Discuss the pros and cons of the report you prepared in (a).
c. Upon further reflection, the chief financial officer (CFO) believes that allocating corporate overhead using divisional revenues is too simplistic. Corporate overhead consists of the following:
R& D .............. $ 420.00
Corporate image advertising..... 330.00
Interest .............. 370.00
Corporate office .......... 280.00
Corporate overhead........ $ 1,400.00
All research and development for the divisions is conducted at the corporate R& D lab. The lab’s total spending of $ 420 million is spent on projects directed specifically at one of the three divisions. As apercentage of total R& D spending, Racing has 50 percent, Passenger 30 percent, and Industrial 20 percent.
Corporate image advertising amounts to $ 330 million. While the content of the ads varies, each ad contains images of Goodstone’s Racing, Passenger, and Industrial products. The general corporate directive, based on market research, is that each print or television corporate image ad should, on average, contain 60 percent of the images or messages drawn from Racing, 30 percent drawn from Passenger, and 10 percent drawn from Industrial. Corporate borrows to finance the operations (current assets and fixed assets) of the three divisions. No division seeks long- term external financing. Of the total current and fixed assets financed externally by the corporate office, 30 percent are in Racing, 50 percent are in Passenger, and 20 percent are in Industrial.
Finally, “Corporate Office” of $ 280 million consists of the CEO, CFO, chief legal counsel, chief information officer, chief human resource officer, and their staffs. The CFO polled each of the senior officers in the Corporate Office asking them how much of their time and their staff’s time was devoted to each of the three divisions. Based on the data, the CFO decided that Corporate Office expenses should be allocated to the three divisions as follows: 40 percent to Racing, 45 percent to Passenger, and 15 percent to Industrial. Based on the preceding information, prepare a revised divisional performance report that satisfies the CFO’s request for a less simplistic, more accurate allocation of corporate overhead.
d. Discuss the pros and cons of the performance report prepared in (c).
e. The corporate strategy of using the Racing Division both as a way to promote Goodstone’s Passenger and Industrial products and also as a way to develop and perfect the next generation of tires was tested when an external consulting firm was hired to estimate the impact on Passenger and Industrial sales from having the Racing Division. Using both longitudinal and cross- sectional data from Goodstone and the tire industry, the consultant concluded that at the current scale of the Racing Division, Racing increases Passenger and Industrial revenues by 10 percent and 5 percent, respectively. Moreover, the consultant concluded that the benefits from corporate image advertising and centralized R& D permeate the entire organization and enhance recruiting and retaining personnel. For example, the R& D lab can attract better engineers and scientists to work on Passenger and Industrial projects because they also work on state- of- the- art racing projects. Corporate R& D projects, while directed specifically at a particular division, provide significant spill- over effects for the other divisions. Lab equipment purchased for Passenger or Industrial projects often is used later on racing projects. And research findings generated on Racing projects almost always have implications for Passenger and Industrial products. In fact, when choosing among R& D projects the head of the lab selects projects that have maximum corporatewide benefits. Based on the findings of the external consultants, prepare another divisional performance report for the three operating divisions.
f. Discuss the pros and cons of the report developed in(e).


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  • CreatedDecember 15, 2014
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