Part A: 4 tasks @ 10 marks each

Task 1 (10 marks) (approximately 500 words)

Blake Romney became Chief Executive Officer of Peters Inc. two years ago. At the time, the

company was reporting lagging profits, and Blake was brought in to stir things up. The company

has three divisions, electronics, fibre optics, and plumbing supplies. Blake has no interest in

plumbing supplies, and one of the first things he did was to put pressure on his accountants to

reallocate some of the companys fixed costs away from the other two divisions to the plumbing

division. This had the effect of causing the plumbing division to report losses during the last two

years; in the past it had always reported low, but acceptable, net income.

Blake felt that this reallocation would shine a favourable light on him in front of the board of directors

because it meant that the electronics and fibre optics divisions would look like they were improving.

Given that these are businesses of the future, he believed that the stock market would react

favourably to these increases, while not penalizing the poor results of the plumbing division. Without

this shift in the allocation of fixed costs, the profits of the electronics and fibre optics divisions would

not have improved.

But now the board of directors has suggested that the plumbing division be closed because it is

reporting losses. This would mean that nearly 500 employees, many of whom have worked for

Peters their whole lives, would lose their jobs.

Required

1. If a division is reporting losses, does that necessarily mean that it should be closed?

2. Was the reallocation of fixed costs across divisions unethical?

3. What should Blake do?

Task 2 (10 marks) (approximately 500 words)

Easton Corporation makes two different boat anchorsa traditional fishing anchor and a high-end

yacht anchorusing the same production machinery. The contribution margin of the yacht anchor is

three times as high as that of the other product. The company is currently operating at full capacity

and has been doing so for nearly two years. Bjorn Borg, the companys CEO, wants to cut back on

production of the fishing anchor so that the company can make more yacht anchors. He says that

this is a no-brainer because the contribution margin of the yacht anchor is so much higher.

Required

Write a short memo to Bjorn Borg describing the analysis that the company should do before it

makes this decision and any other considerations that would affect the decision.

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Task 3 (10 marks)

Twyla Company operates a small factory in which it manufactures two products: C and D.

Production and sales results for last year were as follows.

Product C Product D

Units sold 9,000 20,000

Selling price per unit $95 $75

Variable cost per unit $50 $40

Fixed cost per unit $22 $22

For purposes of simplicity, the firm averages total fixed costs over the total number of units of C and

D produced and sold.

The research department has developed a new product (E) as a replacement for product D. Market

studies show that Twyla Company could sell 10,000 units of E next year at a price of $115; the

variable cost per unit of E is $40. The introduction of product E will lead to a 10% increase in

demand for product C and discontinuation of product D. If the company does not introduce the new

product, it expects next years results to be the same as last years.

Required

Should Twyla Company introduce product E next year? Explain why or why not. Show calculations

to support your decision.

Task 4 (10 marks)

Crede Inc. has two divisions: Division A makes and sells student desks and Division B

manufactures and sells reading lamps.

Each desk has a reading lamp as one of its components. Division A can purchase reading lamps at

a cost of $10 from an outside vendor. Division A needs 10,000 lamps for the coming year.

Division B has the capacity to manufacture 50,000 lamps annually. Sales to outside customers are

estimated at 40,000 lamps for the next year. Reading lamps are sold at $12 each. Variable costs

are $7 per lamp and include $1 of variable sales costs that are not incurred if lamps are sold

internally to Division A. The total amount of fi xed costs for Division B is $80,000.

Required: Consider the following independent situations:

1. What should be the minimum transfer price accepted by Division B for the 10,000 lamps and

the maximum transfer price paid by Division A? Justify your answer.

2. Suppose Division B could use the excess capacity to produce and sell externally 15,000

units of a new product at a price of $7 per unit. The variable cost for this new product is $5

per unit. What should be the minimum transfer price accepted by Division B for the 10,000

lamps and the maximum transfer price paid by Division A? Justify your answer.

3. If Division A needs 15,000 lamps instead of 10,000 during the next year, what should be the

minimum transfer price accepted by Division B and the maximum transfer price paid by

Division A? Justify your answer.

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