Finance Practice Problems

Problem 1
The following data pertain to the Western Division of Jordan Company:

Division total contribution margin
Profit margin controllable by the divisional manager
Average asset investment
$500,000
150,000
600,000
Management bonuses are awarded at the end of each year and based on ROI, and the
company uses responsibility accounting concepts when evaluating performance.
Western's division manager is contemplating the following three investments. Jordan
has a cost of capital of 15% and uses straight line depreciation with no salvage value.
Initial Investment
Annual Expected Profit
(includes depreciation as an expense)
Years
Salvage Value
No. 1
$160,000
32,000
No. 2
$200,000
24,000
No. 3
$300,000
50,000
3
0
3
0
3
0
Use beginning of period book value for all calculations (no need to average with end of
period asset value). In your calculations you might need the following excerpt from the
table in the book:
Present value of an Annuity of $1 in Arrears; (1- (1+ r)-n)/r
Number of years
Rate of return
2
3
4
13%
1.668
2.631
2.974
14%
1.647
2.322
2.914
15%
1.626
2.283
2.855
16%
1.605
2.246
2.798
5
3.517
3.433
3.352
3.274
Problem 1 Part A. (2 points) which investment(s) (if any) would Jordans

shareholders want the division manager to make? Why?
Initial Investment
Years
Annual Expected income
Annual Depreciation (Investment/Years)
CF (Income + Depn.)
Annuity factor (3 years)
I/CF
NPV
No. 1
No. 2
No. 3
$160,000
3
32,000
$200,000
3
24,000
$300,000
3
50,000
$53,333
$66,667
$100,000
$85,333
$90,667
$150,000
2.283
1.875
2.283
2.2058824
2.283
2
$34,816
$6,992
$42,450
Jordans shareholders would want the division manager to invest in all three projects.
Problem 1 Part B. (2 points) Assuming that the Westerns divisional manager expects
to leave the company right after receiving the first coming bonus, which investment(s) (if
any) would the manager of the Westerns division undertake? Why? Is this choice goal
congruent? Why?
Initial Investment
ROI (Income/Investment)
No. 1
No. 2
No. 3
WD
$160,000
$200,000
$300,000
$600,000
32,000
24,000
50,000
150,000
20%
12%
17%
25%
All three projects have a positive NPV and, therefore, are good for the company, but the manager
would not invest in any of them because they have a ROI smaller than the Western Divisions.
Therefore, ROI is not goal congruent in this situation.
Problem 1 Part C. (1 point) Still assuming that the Westerns divisional manager
expects to leave the company right after receiving the first coming bonus, if the manager
of the Westerns division was evaluated with residual income, which investment(s) (if
any) would she undertake? Would her decisions be goal congruent? Why? Show your
answer with calculations.
Initial Investment
RI (Income - r * Investment)
No. 1
No. 2
No. 3
$160,000
$200,000
$300,000
32,000
24,000
50,000
$8,000.0
($6,000.0)
$5,000.0
Residual income does better than ROI but it is still not goal congruent because the
manager would not invest in project 2.
Problem 2
Jerry is the Manager of a division in a manufacturing company that specializes in cell
phones for industrial use. Jerry is evaluated on the ROI of his division, and last year he
obtained a ROI of 14%. Jerry knows that, if he does not improve the ROI of his division
with respect to the previous year, he does not receive a bonus.
The engineering department made a proposal for Jerry consisting of two new products,
the MaxCell and the SuperCell. In this industry, products have typically a good start, but
they become obsolete pretty fast, leading to a fast decline in profits. The controller of the
division is uncertain about the products profitability. He is worried about the future
wellbeing of the division but does not know how to handle the situation.
Problem 2. Part A (2 points)
The following data allowed the controller to calculate the NPV of each project.
Investment Opportunity
Initial investment
Useful life
Salvage value
Expected operating income for
year 1
Operating income annual growth
Required rate of return
MaxCell
$ 6,000,000
4 years
$
-
SuperCell
$ 10,000,000
4 years
$
-
$ 800,000
-10%
14%
$ 1,500,000
-40%
14%
Calculate the NPV of both projects. Should the company undertake these projects?
Investment
Salvage Value
6,000,000
-
MaxCell
Year
Initial
Investment
Profit B/T
6,000,000
800,000
720,000
648,000
583,200
Depreciation
1,500,000
1,500,000
1,500,000
1,500,000
Free Cash Flow
2,300,000
2,220,000
2,148,000
2,083,200
2,017,544
1,708,218
1,449,839
1,233,422
Present Value
NPV
(6,000,000)
The company should undertake the MaxCell project because it has a positive NPV.
409,022
Investment
Salvage Value
$ 10,000,000
$
SuperCell
Year
Initial
Investment
Profit B/T
10,000,000
1,500,000
900,000
540,000
324,000
Depreciation
2,500,000
2,500,000
2,500,000
2,500,000
Free Cash Flow
4,000,000
3,400,000
3,040,000
2,824,000
3,508,772
2,616,190
2,051,913
1,672,035
Present Value
NPV
(10,000,000)
$ (151,090)
The company should not undertake the SuperCell project because it has a negative NPV.
Problem 2. Part B (1.5 points)

Jerry knows that he will leave the company at the end of the first year. He wants to look good and
jump to a new and higher position in another firm. What projects will he invest in? Is ROI a goal
congruent performance measure in this case? Why?
ROI of MaxCell = 800,000/6,000,000 = 13.3%
ROI of SuperCell = 1,500,000/10,000,000 = 15.0%
Since the current ROI is of a 14%, Jerry will invest in the SuperCell project but not on the
MaxCell Project. ROI is not goal congruent because the SuperCell project has a negative NPV
and, therefore, it is not a good project for the company. That is, Jerry will invest in a negative
NPV project. On the contrary, the MaxCell project has a positive NPV and should be undertaken,
but Jerry will not invest on this project because that would lower his ROI.
Problem 2. Part C (1.5 points)

What would be your answer in part B if Jerry was evaluated with the annual RI? Would your
answer change if she planned to stay in the company for 4 years?
One year horizon

Residual Income for MaxCell = 800,000 0.14 * 6,000,000 = -$40,000
Residual Income for SuperCell = 1,500,000 0.14 * 10,000,000 = $100,000
Residual income has the same problem as ROI in this case. MaxCell should be
undertaken from the companys perspective but Jerry will not invest on it because it
would yield him a negative residual income. On the contrary, SuperCell should not be
undertaken but Jerry will invest because it yields a first year positive RI. Therefore, RI is
not goal congruent in this case.
Four years horizon
Thanks to the conservation property of the RI, if Jerry plans to stay in the firm for four
years, he will take the decisions that are optimal for the company because he will want to
maximize NPV.
Problem 1
Community Coffee Company (CCC) is a processor and distributor of gourmet coffees
sold in grocery stores through the Southeastern United States. CCC buys coffee beans
from around the world and roasts, blends and packages them for resale. CCC currently
produces 15 gourmet blends which it sells in 1 pound bags. Some coffee blends are very
popular and sell at a very high volume, while other, newer blends sell at low volumes.
CCC sells its coffee at full cost (i.e., direct costs plus overhead costs) plus a 30% markup (that is, the price is 1.3 times the full cost).
Data for the 2006 budget include manufacturing overhead of $2,600,000, which has been
allocated based upon direct labor cost (i.e. labor $). The budgeted direct labor cost for
2006 is $1,000,000.
Anticipated unit costs for two of the 15 different blends that CCC produces are as
follows:
(note 1 pound of coffee = 1 unit):
Direct material
Direct labor
Jamaican
$2.90
$0.50
Slow Roasted Kona

$3.95
$0.40
Community Coffee recently hired a new controller who is concerned that the traditional
costing system may be providing misleading information and is considering
implementing activity based costing. She has developed a detailed analysis of the
companys 2006s budgeted manufacturing overhead costs (shown below):
Activity
Quality Controls
Material Handling
Packaging
Purchasing
Roasting and
Blending
Cost Driver
Batches
Set-ups
Packaging Hours
Purchase Orders
Machine Hours
Activity Capacity
4,000
6,000
12,000
80,000
180,000
Budgeted Cost
$300,000
$600,000
$500,000
$400,000
$800,000
Data regarding the total production requirements for both blends of coffee are shown in
the following table. Assume there was no raw material inventory for either coffee at the
beginning of the year:
Budgeted Sales
Number of Batches
Setups
Packaging Time
Purchase Orders
Machine Hours
Jamaican
30,000 lbs
20 batches
20
2,000 hours
800
2,000 hours
Slow Roast Kona

9,000 lbs
9 batches
9
700 hours
800
8,000 hours
Problem 1 Part A. (5 points)

Using CCCs current product costing system, determine the full product cost and selling
prices for 1 pound of both types of coffee.
Total budgeted overhead/cost driver = $2,600,000/$1,000,000 = $2.6 per DL cost
Product cost:
Selling price:
Jamaican
DM
2.90
DL
.50
OH (2.6) X .5 = 1.30
Total
= 4.70
Jamaican
4.70 X 1.30 = $6.11
Kona
DM
3.95
DL
.40
OH (2.6) X .4 = 1.04
Total
= 5.39
Kona
5.39 X 1.30 = $7.01
Problem 1 Part B. (20 points)

Using activity based costing, determine the new product costs for 1 pound of both types
of coffee.
COST
QC
300,000
MH
600,000
PACK
500,000
PURCH
400,000
R&B
800,000
TOTAL 2,600,000
QC
MH
PACK
PURCH
R&B
TOTAL
Cost
Driver
Consumed
20
20
2000
800
2000
Total
POH
ACTIVITY
PRACTICAL
CAPACITY
4,000
6,000
12,000
80,000
180,000
ALLOCATION
RATE
75
100
41.67
5
4.44
Jamaican
Allocated OH Allocated OH /
unit
1500
2000
83,340
4000
8889
0.05
0.07
2.78
0.13
0.30
3.33
Product cost:
Jamaican
DM
DL
OH
Total
Kona
2.90
.50
3.33
6.73
3.95
.40
7.81
12.16
Cost
Driver
Consumed
9
9
700
800
8000
Total POH
Kona
Allocated Allocated
OH
OH / unit
675
900
29169
4000
35520
0.08
0.1
3.24
0.44
3.95
7.81
Problem 1 Part C. (10 points)

Interpret the new information provided by the ABC system.
Based on the information provided by the ABC system what would you recommend to
CCC as far as product pricing is concerned?
The interpretation of the ABC results:
The traditional costing system overcosted the higher volume product (Jamaican)
because it requires a bit more direct labor, and undercosted the lower volume more
specialty item (Kona). As a result, CCC was selling Kona at a price below cost. This
is a frequent distortion that occurs with traditional costing (undercost low volume,
overcost high volume).
ABC corrects the distortions by taking into account the usage of capacity resources.
It allocates the different activity costs according to a cost driver that measures the
capacity usage of each product. With ABC the higher consumption of resources
required to produce Kona is reflected in the cost. Kona requires more machine hours
per unit and more frequent batches. When this is reflected in the cost, one sees that
Kona cost almost double than Jamaican.
Pricing:
CCC should try to increase the price for Kona. At the current price of $7.01, longterm profitability is not possible. If the market does not allow the price increase, CCC
should try to replace the product, but always taking into account that from a shortterm perspective Kona has a positive contribution margin. Therefore, unless enough
capacity resources are avoidable, CCC should not drop Kona immediately, but
instead think of a product replacement.
Problem 2
Safety Doors Inc. manufactured three lines of products until 2008: Come-on-in, Who-is-it
and Stay-out. In 2008, after working at practical capacity, a report elaborated by the
controller showed that Who-is-it had a negative product profit margin. The controllers
following income statement was elaborated allocating Manufacturing Overhead
according to direct labor dollars:
Income Statement (2008)
Volume (units)
Revenues
Direct Materials
Direct Labor
Manufacturing Overhead
Product Profit Margin
Sales and Administration
Profit before taxes
Come-on-in
4,000
$1,000,000
$400,000
$320,000
$160,000
$120,000
Stay-out
1,000
$500,000
$400,000
$40,000
$20,000
$40,000
Who-is-it
9,000
$1,620,000
$900,000
$540,000
$270,000
($90,000)
Total
$3,120,000
$1,700,000
$900,000
$450,000
$70,000
$50,000
$20,000
Max Gates, CEO of Safety Doors, was convinced that the disappointing result in 2008
was caused by the Who-is-it product line. Consequently, he decided to drop it to redress
the situation. Since the practical capacity remained unaltered, Max knew that he would
have to deal with idle capacity in the future, but he was still convinced he made the right
choice. However, in 2009, the controllers report did not confirm his conviction:
Income Statement (2009)
Volume (units)
Revenues
Direct Materials
Direct Labor
Profit before taxes
Come-on-in Stay-out
Total
4,000
1,000
$1,000,000 $500,000 $1,500,000
$400,000 $400,000 $800,000
$320,000
$40,000 $360,000
$400,000
$50,000 $450,000
($120,000)
$10,000 ($110,000)
$50,000
($160,000)
Problem 2 Part A (16 points)

Max Gates has recently heard about a new costing system called ABC. He wants you to
analyze the profitability of the three products with this new system. He provides you with
the following additional information:
Activities
Machining
Setup
Total Manufacturing Overhead
Cost Driver
Machine Hours
Number of Batches
Come-on-in
Machine hours per unit
Batch Size (units)
2
100
Cost
$300,000
$150,000
$450,000
Stay-out
10
10
Who-is-it
2
100
Required:
1) Elaborate a new ABC income statement for 2008 containing the product margin
for each product and the margin and profit for the whole company.
2) Explain the difference in the margins between the new ABC system and the
controllers calculations (DONT FORGET THIS PART!!).
First we need to calculate the total capacity for each activity cost driver. Since in 2008
the firm is working at capacity, the total cost driver volume in 2008 is the practical
capacity.
The number of machine hours consumed by a product line is just the number of product
units times the number of machine hours per product unit.
The number of batches used in a product line is the number of product units sold for that
product line divided by the batch size of that product line.
Activity
Machining
Setup
Cost Driver
Machine hours
Number of Batches
Come-on-in
Stay-out
8,000
40
10,000
100
Total
(Practical
Who-is-it Capacity)
18,000
90
36,000
230
Now that we have the practical capacity for both activities, we can calculate the
allocation rates:
Activity
Machining
Setup
Cost
$300,000
$150,000
Cost Driver
Machine hours
Batch Number
Practical Capacity
36,000
230
Driver Rate
8.33
652
With the allocation rates we allocate the cost of each activity to each product line:
Activity
Machining
Setup
Come-on-in
Driver Allocation
8,000
$66,667
40
$26,087
Stay-out
Driver Allocation
10,000
$83,333
100
$65,217
Who-is-it
Driver Allocation
18,000 $150,000
90
$58,696
With these allocations, we can now write the ABC income statement for 2008:
ABC Income Statement (2009)
Revenues
Direct Materials
Direct Labor
Manufacturing Overhead:
Machining
Setup
Unused Capacity
Profit before taxes
Come-on-in Stay-out
Who-is-it
Total
1,000,000
500,000 1,620,000 3,120,000
400,000
400,000
900,000 1,700,000
320,000
40,000
540,000
900,000
66,667
26,087
187,246
83,333
65,217
-88,551
150,000
58,696
-28,696
300,000
150,000
70,000
50,000
0
20,000
We can see that Safety Doors is loosing money not only on the Who-is-it but also on the
Stay-out line as well. On the other hand, Come-on-in is even more profitable than
initially thought. The Stay-out product line is produced in small batches and therefore
consumes a lot of setup resources that were not properly allocated by the controller. In
addition, Stay-out consumes a lot more machine hours per unit than the other product
lines. These two facts are not properly reflected by the labor dollars cost driver that the
controller used to elaborate the report. Instead, Come-on-in and Who-is-it are more
labor intensive products than Stay-out and get overcharged with overhead costs in the
traditional absorption costing system used by the controller.
Problem 2 Part B (8 points)

Calculate and write the ABC income statement for 2009. In doing so, assume that the
additional information provided in part A is also true for 2009. (Hint: This should be a
short exercise given the common data between the 2 years. Many of the calculations do
not need to be redone.)
Since practical capacity did not change in 2009, and the overhead is the same as in 2008,
the allocation rates for both activities are the same as in 2009. Moreover, since the
number of units of Come-on-in and Stay-out sold in 2009 is the same as the one sold in
2008, the profit margins for Come-on-in and Stay-out will be unchanged. The overhead
that was allocated to Who-is-it will now become the cost of unused capacity. With these
changes, the ABC income statement becomes:
ABC Income Statement (2009)

Revenues
Direct Materials
Direct Labor
Machining
Setup
Unused Capacity
Profit before taxes
Come-on-in Stay-out
Total
1,000,000
500,000 1,500,000
400,000
400,000
800,000
320,000
40,000
360,000
66,667
26,087
187,246
83,333
65,217
-88,551
150,000
91,304
98,696
50,000
208,696
-160,000
Problem 2. Part C (6 points)

Max is determined to do whatever is necessary to save the company. He is now
pondering whether to restrict production to the only profitable product left according to
his controllers calculations in 2009, Stay-out. Before taking any drastic action, however,
he wants you to let him know what you think is happening.
Required:
1) Explain to Max why his decision making process is wrong.
Max is a victim of the inaccurate information provided to him by the controller. The
controller is using a traditional absorption costing system. As a result, he is using total
volume of labor as the allocation denominator. When Max decided to drop the Who-is-it
product line, no capacity costs were eliminated. In 2009, the traditional costing system
reallocated those capacity costs to the remaining product lines making them look even
less profitable. Therefore, he is falling into the Death Spiral trap.
In this firm the consumption of capacity resources by the three product lines is very
different and the cost of those capacity resources is economically significant. Therefore,
the allocation of capacity costs needs to be done carefully. The traditional costing system
does not do a good job on that, distorting the product costs and leading Max to take the
wrong decisions.
2) Give Max two recommendations that may help him to redress the situation
Max could improve the situation by:
1) Not dropping the Come-on-in product line as he seems to be thinking on doing. It
is the most profitable!
2) Increasing the prices of Stay-out and Who-is-it. These products are not profitable
at the current prices from a long term perspective. If competition does not allow
Max to increase prices, he needs to evaluate other solutions. He must either find a
way to reduce costs or stat thinking of alternative products to use the available
capacity.
3) Reduce the number of batches in the Stay-out line by increasing the batch size.
This could be done by standardizing the product line, increasing inventories of
finished products,
4) Perhaps the Come-on-in product line could be expanded. The current profitability
of this product might allow the firm to gain market share with a reduction of
prices. If demand responds positively because competitors do not retaliate, this
would be a good way to increase profits.
Problem 1
P4-43.
($ in millions)
a. 2011 NOPAT
= $1,118 - ($378 + ($127 0.37) = $693
b. 2011 NOA
= $7,462 $1,506 $846 $375 $652 $495 $292 = $3,296
2010 NOA
c. 2011 RNOA
= $6,579 - $795 $726 $336 $596 $469 $267 = $3,390

= $693 / [ ($3,296 + $3,390) / 2 ] = 20.73%
2011 NOPM
= $693/$9,700 = 7.14%
2011 NOAT
= $9700 / [ ($3,296 + $3,390) / 2 ] = 2.90
2011 RNOA
= 7.14% 2.90 = 20.73% (0.0002 rounding error)
Nordstroms net operating profit margin of 7.14% is significantly above the industry
median of 4.46%, which is not surprising given the companys high-end product.
Nordstroms net operating asset turnover ratio of 2.90 is just slightly higher than the
industry median NOAT of 2.81. It appears that Nordstrom is managing both its
income statement and its balance sheet very well.
d. 2011 NNO
Confirm:
2010 NNO
Confirm:
e. 2011 ROE
f.
= $6 +$ 2,775 $1,506 = $1,275

$3,296 = $1,275 + $2,021
= $356 + $2,257 $795 = $1,818
$3,390 = $1,818 + $1,572
= $613 / [ ($2,021 + $1,572) / 2 ] = 34.12%
2011 nonoperating return = ROE RNOA = 34.12% 20.73% = 13.39%
g. ROE>RNOA implies that Nordstrom is able to borrow money to fund operating

assets that yield a return greater than the cost of its debt. The excess accrues to the
benefit of Nordstroms stockholders.
Problem 1
The following data pertain to the Western Division of Jordan Company:
Division total contribution margin
Profit margin controllable by the divisional manager
Average asset investment
$500,000
150,000
600,000
Management bonuses are awarded at the end of each year and based on ROI, and the
company uses responsibility accounting concepts when evaluating performance.
Western's division manager is contemplating the following three investments. Jordan
has a cost of capital of 15% and uses straight line depreciation with no salvage value.
Initial Investment
Annual Expected Profit
(includes depreciation as an expense)
Years
Salvage Value
No. 1
$160,000
32,000
No. 2
$200,000
24,000
No. 3
$300,000
50,000
3
0
3
0
3
0
Use beginning of period book value for all calculations (no need to average with end of
period asset value). In your calculations you might need the following excerpt from the
table in the book:
Present value of an Annuity of $1 in Arrears; (1- (1+ r)-n)/r
Number of years
Rate of return
2
3
4
13%
1.668
2.631
2.974
14%
1.647
2.322
2.914
15%
1.626
2.283
2.855
16%
1.605
2.246
2.798
5
3.517
3.433
3.352
3.274
Problem 1 Part A. (2 points) which investment(s) (if any) would Jordans

shareholders want the division manager to make? Why?
Initial Investment
Years
Annual Depreciation (Investment/Years)
CF (Income + Depn.)
Annuity factor (3 years)
I/CF
NPV
No. 1
No. 2
No. 3
$160,000
3
32,000
$200,000
3
24,000
$300,000
3
50,000
$53,333
$66,667
$100,000
$85,333
$90,667
$150,000
2.283
1.875
2.283
2.2058824
2.283
2
$34,816
$6,992
$42,450
Jordans shareholders would want the division manager to invest in all three projects.
Problem 1 Part B. (2 points) Assuming that the Westerns divisional manager expects
to leave the company right after receiving the first coming bonus, which investment(s) (if
any) would the manager of the Westerns division undertake? Why? Is this choice goal
congruent? Why?
Initial Investment
ROI (Income/Investment)
No. 1
No. 2
No. 3
WD
$160,000
$200,000
$300,000
$600,000
32,000
24,000
50,000
150,000
20%
12%
17%
25%
All three projects have a positive NPV and, therefore, are good for the company, but the manager
would not invest in any of them because they have a ROI smaller than the Western Divisions.
Therefore, ROI is not goal congruent in this situation.
Problem 1 Part C. (1 point) Still assuming that the Westerns divisional manager
expects to leave the company right after receiving the first coming bonus, if the manager
of the Westerns division was evaluated with residual income, which investment(s) (if
any) would she undertake? Would her decisions be goal congruent? Why? Show your
answer with calculations.
Initial Investment
RI (Income - r * Investment)
No. 1
No. 2
No. 3
$160,000
$200,000
$300,000
32,000
24,000
50,000
$8,000.0
($6,000.0)
$5,000.0
Residual income does better than ROI but it is still not goal congruent because the
manager would not invest in project 2.
Problem 2
Jerry is the Manager of a division in a manufacturing company that specializes in cell
phones for industrial use. Jerry is evaluated on the ROI of his division, and last year he
obtained a ROI of 14%. Jerry knows that, if he does not improve the ROI of his division
with respect to the previous year, he does not receive a bonus.
The engineering department made a proposal for Jerry consisting of two new products,
the MaxCell and the SuperCell. In this industry, products have typically a good start, but
they become obsolete pretty fast, leading to a fast decline in profits. The controller of the
division is uncertain about the products profitability. He is worried about the future
wellbeing of the division but does not know how to handle the situation.
Problem 2. Part A (2 points)
The following data allowed the controller to calculate the NPV of each project.
Investment Opportunity
Initial investment
Useful life
Salvage value
Expected operating income for
year 1
Operating income annual growth
Required rate of return
MaxCell
$ 6,000,000
4 years
$
-
SuperCell
$ 10,000,000
4 years
$
-
$ 800,000
-10%
14%
$ 1,500,000
-40%
14%
Calculate the NPV of both projects. Should the company undertake these projects?
Investment
Salvage Value
6,000,000
-
MaxCell
Year
Initial
Investment
Profit B/T
6,000,000
800,000
720,000
648,000
583,200
Depreciation
1,500,000
1,500,000
1,500,000
1,500,000
Free Cash Flow
2,300,000
2,220,000
2,148,000
2,083,200
2,017,544
1,708,218
1,449,839
1,233,422
Present Value
NPV
(6,000,000)
The company should undertake the MaxCell project because it has a positive NPV.
409,022
Investment
Salvage Value
$ 10,000,000
$
SuperCell
Year
Initial
Investment
Profit B/T
10,000,000
1,500,000
900,000
540,000
324,000
Depreciation
2,500,000
2,500,000
2,500,000
2,500,000
Free Cash Flow
4,000,000
3,400,000
3,040,000
2,824,000
3,508,772
2,616,190
2,051,913
1,672,035
Present Value
NPV
(10,000,000)
$ (151,090)
The company should not undertake the SuperCell project because it has a negative NPV.
Problem 2. Part B (1.5 points)

Jerry knows that he will leave the company at the end of the first year. He wants to look good and
jump to a new and higher position in another firm. What projects will he invest in? Is ROI a goal
congruent performance measure in this case? Why?
ROI of MaxCell = 800,000/6,000,000 = 13.3%
ROI of SuperCell = 1,500,000/10,000,000 = 15.0%
Since the current ROI is of a 14%, Jerry will invest in the SuperCell project but not on the
MaxCell Project. ROI is not goal congruent because the SuperCell project has a negative NPV
and, therefore, it is not a good project for the company. That is, Jerry will invest in a negative
NPV project. On the contrary, the MaxCell project has a positive NPV and should be undertaken,
but Jerry will not invest on this project because that would lower his ROI.
Problem 2. Part C (1.5 points)

What would be your answer in part B if Jerry was evaluated with the annual RI? Would your
answer change if she planned to stay in the company for 4 years?
One year horizon

Residual Income for MaxCell = 800,000 0.14 * 6,000,000 = -$40,000
Residual Income for SuperCell = 1,500,000 0.14 * 10,000,000 = $100,000
Residual income has the same problem as ROI in this case. MaxCell should be
undertaken from the companys perspective but Jerry will not invest on it because it
would yield him a negative residual income. On the contrary, SuperCell should not be
undertaken but Jerry will invest because it yields a first year positive RI. Therefore, RI is
not goal congruent in this case.
Four years horizon
Thanks to the conservation property of the RI, if Jerry plans to stay in the firm for four
years, he will take the decisions that are optimal for the company because he will want to
maximize NPV.
Problem 1
Castaway Products uses a standard costing system to assist in the evaluation of operations. The
company has had considerable employee difficulties in recent months. To redress the situation,
management has hired a new production supervisor (Joe Simms). Simms has been on the job for
six months and has seemingly brought order to an otherwise chaotic situation.
The vice-president of manufacturing recently commented that Simms has really done the trick.
Joes team-building/morale-boosting approach has truly brought things under control. The vicepresidents comments were based on both a plant tour, where he observed a contented work force,
and review of a performance report that showed a flexible budget labor variance of $14,000F and a
flexible budget direct-material variance of $5,000U. The vice-president is especially impressed by
these variances, because they are less than 2% of the companys budgeted labor and direct-material
costs respectively. Additional data (that the VP did NOT see) follow:
Total completed production amounted to 20,000 units.
Castaway reported a direct-material price variance of $117,000F, approximately 10% of budgeted
material cost.
A review of the firms budgeted cost records found that each completed unit requires 2.75 hours of
labor at $14 per hour.
Castaways production actually required 42,000 labor hours at a total cost of $756,000.

Calculate Castaways direct-labor price and efficiency variances. Calculate the direct-materials
efficiency variance.
Actual Labor Cost

Actual
Hours
42,000
As if Budget
Actual
Rate
Actual
Hours
x
$18.00*
42,000
x
$756,000
$588,000
$168,000U
Direct-labor
rate variance
Flexible Budget
Standard
Rate
No need to calculate
$14.00
$182,000F**
Direct-labor
efficiency variance
Flexible Budget Labor Variance $14,000F
*$756,000 42,000 hours

** Flexible Budget Labor Variance = Direct labor rate variance + Direct labor efficiency variance = $14,000
Thus, we just need to calculate:
Direct labor efficiency variance
DL price variance:
DL efficiency variance:
= Flexible Budget Labor Variance - Direct labor rate variance

=14,000 (-168,000) = 182,000 F
$168,000 unfavorable
$182,000 favorable
DM efficiency variance = DM flexible budget variance DM price variance =

= - $5,000 $117,000 = - $122,000 = $122,000U

Evaluate Simms based on the direct-labor and direct-material variances. Does the vice-president
have a clear picture of what is going on? Given that you have more information than the vicepresident, can you give any alternative explanation to the variances? (Make sure you explain a
consistent story that fits the variances available and takes into account interactions between
variances.)
The student could say something about how the variance is larger than the report suggests or that
breaking them out gives more information
Castaway should be concerned. Although the combined variance of $14,000F is small, a more
detailed analysis reveals the presence of sizable, offsetting variances. Both the rate variance and
the efficiency variance are in excess of 21% of budgeted amounts ($770,000). A variance
investigation should be undertaken if benefits of the investigation exceed the costs. Put simply,
things are not going as smoothly as the vice-president believes.
A Plain interpretation of variances without interactions
The favorable efficiency variance means that the company is producing units by consuming fewer
hours than expected. This may be the result of the team-building/morale-boosting exercises, as a
contented, well-trained work force tends to be efficient in nature. However, another totally plausible
explanation could be that Castaway is paying premium wages (as indicated by the unfavorable rate
variance) to hire laborers with above-average skill levels.
Indicating something about interdependencies
There may be a relationship between the two variances. The favorable labor efficiency variance
may partially explain the unfavorable material quantity variance. That is, laborers may be rushing
through their jobs and using more material than standard.
Problem 2 Tuscany Statuary manufactures bust statues of famous historical figures. All statues are
the same size. Each unit requires the same amount of resources. The following data is from the
master budget for 2008:
Expected production and sales
Direct materials
Direct manufacturing labor
Total fixed costs
5000 units
50,000 pounds
20,000 hours
$1,000,000
Budgeted input quantities, prices and unit costs follow for direct materials and direct labor.
Direct materials
Direct labor
Budgeted Input
Quantity
(per unit of output)
10 pounds
4 hours
Budgeted Price
Budgeted Unit Cost
$10 per pound

$40 per hour
$100
$160
During 2008, actual number of units produced and sold was 6,000. Actual cost of direct materials
used was $594,000, based on 54,000 pounds purchased at $11 per pound. Direct manufacturing
labor-hours actually used were 25,000, at the rate of $38 per hour. This resulted in actual direct
manufacturing labor costs of $950,000. Actual fixed costs were $1,005,000. There were no
beginning and ending inventories.
Problem 2, Part A. (20 points).

Calculate the (variable-cost) sales-volume variance and (variable-cost) flexible-budget variance
for direct materials and direct labor. Show and very clearly label your work.
Actual
Results
Units sold
Direct materials
FlexibleBudget
Variances
(1)
(2) = (1) (3)
a
6,000
0
$ 594,000
Direct manufacturing labor 950,000a

Fixed costs
1,005,000a
Total costs
$2,549,000
Flexible
Budget
SalesVolume
Variances
Static
Budget
(3)
(4) = (3) (5)
6,000
1,000 F
$ 6,000 F $ 600,000 b $100,000 U $ 500,000c

10,000 F
960,000d 160,000 U
800,000e
5,000 U 1,000,000a
0
1,000,000a
$11,000 F $2,560,000 $260,000 U $2,300,000
$11,000 F
$260,000 U
Flexible-budget variance
Sales-volume variance
$249,000 U
Static-budget variance
a
Given
$100 6,000 = $600,000
c
$100 5,000 = $500,000
d
$160 6,000 = $960,000
e
$160 5,000 = $800,000
b
(5)
5,000a
Problem 2, Part B. (20 points) Compute price and efficiency variances for direct
materials and direct labor. Show and very clearly label your work.
Actual
As If
Flexible
IA*NA*QA
IB*NA*QA
IB*NB*QA
$594,000a
$540,000b
$600,000c
Budget
Direct materials
$54,000 U
$60,000 F
Price variance
Efficiency variance
$6,000 F
$950,000a
$960,000f
$1,000,000e
$50,000 F
Price variance
$40,000 U
Efficiency variance
$10,000 F
a
54,000 pounds $11/pound = $594,000

54,000 pounds $10/pound = $540,000
c
6,000 statues 10 pounds/statue $10/pound = 60,000 pounds $10/pound =
$600,000
d
25,000 pounds $38/pound = $950,000
e
25,000 pounds $40/pound = $1,000,000
f
6,000 statues 4 hours/statue $40/hour = 24,000 hours $40/hour = $960,000
b
Problem 2, Part C. (20 points).

The company is organized in three departments: purchasing, production and marketing.
Recently, the purchasing manager and the production manager have been arguing about
quality vs. efficiency issues. Provide the manager of Tuscany Statuary with an idea as to
what may have caused and who might be responsible for the following variances as you
calculated them in Parts A and B:
i)
ii)
iii)
Sales volume variances

Direct materials price variance
Direct labors efficiency variance
The following are some of the possible interpretations of the resulting variances:
Direct materials unfavorable price variance may have been caused by the purchasing
department
(1) paying higher price than the standard for the period
(2) changing to a new vendor
(3) buying higher-quality materials
Direct materials favorable efficiency variance may have been caused by the production
department
(1) making employee/machinery working more efficiently and having less scrap and
waste materials
(2) buying better-quality materials. Notice that, since the direct materials flexible
budget variance is favorable, this interpretation would make the increase in
quality of direct materials a good decision of the purchasing department.
(3) changing the production process.
Direct labors favorable price variance may have been caused by the production
department
(1) changing the work force by hiring lower-paid employees
(2) changing the mix of skilled and unskilled workers
(3) not giving pay raises as high as anticipated when the standards were set for the
year
(4) having to pay less over-time due to a higher efficiency in the production process
Direct labors unfavorable efficiency variance may have been caused by the production
department
(1) changing the mix of skilled and unskilled workers. This interpretation is coherent
with the favorable labor price variance being caused with lower paid workers.
Overall, since the labor flexible variance is favorable, this would have been a
good decision of the production department. Nevertheless, one should also
consider the effects of these changes on the quality of the final product.
(2) The workforce was increased with unskilled workers to avoid paying overtime.
This would be consistent with the favorable labor price variance.
(3) changes of production process (learning something new takes time). This would
be consistent with a process change that reduces spoilage or rework and,
therefore, produces a favorable direct materials efficiency variance.
(4) different types of direct materials to work with. This could also be related to a
change of materials decided by the purchasing department.
(5) poor working conditions or poor attitudes on behalf of the workers. This might
be consistent with giving lower raises to the workforce and thereby obtaining a
favorable labor price variance.
Sales volume variances: all sales volume variance are unfavorable because volume
increased. This might be because the marketing department has did a better job than
expected in promoting sales, or because the marketing department did not forecast sales
accurately (or both). In any case, an unexpected high volume of sales may also be related
to the unfavorable labor efficiency and direct materials price variances because of rush
orders, stock-outs or capacity issues.
Problem 1
The California Instrument Company (CIC) consists of the Semiconductor Division (SD)
and the Process-Control Division (PCD), each of which operates as an independent profit
center.
The SD employs craftsmen to produce two different electronic components: the new
high-performance Super-chip and an older product called Okay-chip. These two products
have the following cost characteristics:
Super-chip
Direct materials
$2
(2 hours x $14/hour =)
$28
Okay-chip
$1
(.5 hours x $14/hour =)
$7
Annual overhead in SD totals $400,000, all fixed. Due to the high skill level necessary
for the craftsmen, the SDs capacity is set at 50,000 hours per year.
The current market price for Super-chips is $60 per chip with a maximum external
demand of 15,000 units per year. The maximum external demand for Okay-chip is 50,000
units at $12 per chip.
The PCD produces and sells only one product to the external market, a process-control
unit, with the following cost structure:
Direct materials (circuit board, bought to an external supplier): $60
Direct manufacturing labor (5hours x $10/hour): $50
Fixed overhead of the PCD is $80,000 per year. The current market price for the processcontrol unit is $132 per unit.
A joint research project has just revealed that a single Super-chip could replace the circuit
board currently used to make the process-control unit. Using a Super-chip would require
one extra labor hour per process-control unit for a new total of 6 hours per-control unit
manufactured in the PCD.
Problem 1 - Part A (1 point)

If no transfers of Super-chips are made to the PCD, how many Super-chips and Okaychips should the SD sell to the external market? Show your computations.
Super-chip
Selling price
$60
Direct material cost per unit
2
Direct manufacturing labor cost per unit 28
Contribution margin per unit
$30
Contribution margin per hour
($30 2; $4 0.5)
$15
Okay-chip
$12
1
7
$ 4
$ 8
Because the contribution margin per hour is higher for Super-chip than for Okaychip, CIC should produce and sell as many Super-chips as it can and use the remaining
available capacity to produce Okay-chip.
The total demand for Super-chips is 15,000 units, which would take 30,000 hours (15,000
2 hours per unit). CIC should use its remaining capacity of 20,000 hours (50,000
30,000) to produce 40,000 Okay-chips (20,000 0.5).
Problem 1 - Part B (2 points)

The PCD expects to sell 5,000 process-control units this year. From the viewpoint of CIC
as a whole, should 5,000 Super-chips be transferred from the SD to the PCD to replace
circuit boards? Show your computations.
Possible Different Calculations:
Overall Company Viewpoint
Alternative 1: No Transfer of Super-chips:
Sell 15,000 Super-chips at contribution margin per unit of $30
Sell 40,000 Okay-chips at contribution margin per unit of $4
Sell 5,000 Control units at contribution margin per unit of $22
Total contribution margin
$450,000
160,000
110,000
$720,000
Alternative 2: Transfer 5,000 Super-chips to Process-Control Division. These Superchips would require 10,000 hours to manufacture, leaving only 10,000 hours for the
manufacture of 20,000 Okay-chips (10,000 0.5):
Sell 15,000 Super-chips at contribution margin per unit of $30
$450,000
80,000
210,000
$740,000
CIC is better off transferring 5,000 Super-chips to the Process-Control Division.
Some students might have shortened the calculations by not considering non-relevant
contributions. For instance, the contribution from the sale of 15,000 Super-chips to the
market happens in both alternative scenarios with the same contribution margin per unit.
Therefore, it can be disregarded.
160,000
110,000
$270,000
80,000
210,000
$290,000
The students can even go further in simplifying the calculations and realize that there will
be 20,000 Okay-chips difference between alternatives
80,000
110,000
$190,000
210,000
$210,000
Another approach is to consider the difference in contribution margins of selling the

5,000 Super-chips in the two alternative scenarios and then take into account the
opportunity cost of producing it in the SD as opposed to buying externally.
Alternative 2 vs. 1
- Sell 5,000 Control units at contribution margin per unit of $22
- Opportunity cost of selling 20,000 Okay-chips
at contribution margin per unit of $4
210,000
110,000
80,000
$20,000
An even shorter approach is to consider the difference in cost of selling the 5,000 Superchips in the two alternative scenarios and then take into account the opportunity cost of
producing it in the SD as opposed to buying externally.
Alternative 2 vs. 1
- Sell 5,000 Control units at contribution margin per unit of $22
- Opportunity cost of selling 20,000 Okay-chips
at contribution margin per unit of $4
210,000
110,000
80,000
$20,000
Problem 1 - Part C (2 points)

The PCD still expects to sell 5,000 process control units this year. Calculate the minimum
transfer price at which the SD would be willing to sell the Super-chip to the PCD, and the
maximum transfer price the PCD would be willing to pay for it.
For each Super-chip that is transferred, two hours of time (labor capacity) are given up
in the Semiconductor Division, and, in those two hours, four Okay-chips could be
produced, each contributing $4.
Minimum transfer price
=
per Super - chip
=
=
Incremental cost
Opportunity cost per unit for
+ the Semiconductor Division
per unit to
the point of transfer
$30 + $16
$46 per unit
If the selling price for the process-control unit were firm at $132, the ProcessControl Division would accept any transfer price up to $50 ($60 price of circuit board
$10 incremental labor cost if Super-chip used).
Problem 2.
The Shamrock Company manufactures and sells television sets. Its Assembly Division
(AD) buys television screens from the Screen Division (SD) and assembles the TV sets.
The SD, which is operating at capacity, incurs an incremental manufacturing cost of $80
per screen. The SD can sell all its output to the outside market at a price of $120 per
screen, after incurring a variable marketing and distribution cost of $5 per screen. This
variable marketing cost is not incurred if the television screens are sold internally. If the
AD purchases screens from outside suppliers at a price of $120 per screen, it will incur a
variable purchasing cost of $3 per screen. This cost is not incurred if the supplier is the
SD. Shamrocks division managers can act autonomously to maximize their own
divisions operating income.
Problem 2 Part A. (2 points). If the divisions are allowed full discretion to negotiate a
transfer price, can an internal transfer take place and at what transfer price? Is this goal
congruent?
5000
custom
screens
SD
uvcSD= $80
TP
screens
PSD=$120/s
uvmcSD= $5/s
Televisions
AD
uvcAD = ?
PAD=$120/s
uvpcAD= $3/s
PT=$?
screens
Division SD
Division SD
Revenues
- uvcSD
- uvmcSD
CMA
Thus, Division A will be indifferent if
That is, TPmin = 80 +35 = $115/cs
Status Quo
120
-80
-5
35
35 = TPmin 80
Accept Transfer
TPmin
-80
0
TPmin - 80
Division AD
Division AD
Per unit
Price
- uvcAD
-screen cost
-uvpcAD
ucmAD
Status Quo
0
0
0
0
0
Accept Transfer
PT
- uvcAD
- TPmax
0
PT - uvcAD - TPmax
Buy Externally
PT
- uvcAD
- 120
-3
PT - uvcAD -123
Thus, Division B will be indifferent between accepting the transfer and buying externally
if
TPmax = $123/s.
A negotiated transfer price can be agreed in the range TP [115, 123]
This is goal congruent because for the company as a whole it is best if the transfer takes
place. Since both divisions profit from the transaction, the company as a whole must
profit as well. This can also be seen easily because by transferring internally, the
company saves the marketing and distribution cost and the purchasing cost.
Problem 2 Part B. (3 points). Suppose that the SD can sell only 8,000 screens per
month externally and has an output capacity of 12,000 screens per month. Capacity
cannot be reduced in the short run. The AD can assemble and sell 8,000 TV sets per
month. For operational efficiency reasons, order size needs to be a multiple of 4,000
screens. The AD has found a supplier willing to sell screens for $100 per screen.
a. For each possible order size, what is the minimum transfer price at which the SD
manager would be willing to sell screens to the AD?
b. If allowed to negotiate, will there be trade between divisions? If yes, at what
transfer price and order size?
c. From the point of view of Shamrocks shareholders how much of the SD output
should be transferred to the AD? Is negotiation a goal congruent method to
determine the transfer price in this case?
a. The only two possible order sizes are 4,000 and 8,000 screens because AD cannot
sell more than that.
Order Size: 4,000 screens
Division SD
Revenues
- uvcSD
- uvmcSD
ucmSD
That is, TPmin = 80 = $80/s
Status Quo
0
0
0
0
Accept Transfer
4,000*TPmin
-4,000*80
0
4,000*(TPmin 80)
0 = 4,000*(TPmin 80)

Division SD
Revenues
- uvcSD
- uvmcSD
ucmSD
Status Quo
4,000*120
-4,000*80
-4,000*5
4,000*35
Accept Transfer
8,000*TPmin
-8,000*80
0
8,000*(TPmin 80)

4,000*35 = 8,000*(TPmin 80)
That is, TPmin = 80 +4,000*35 /8,000= $97.5/s
b.
Division AD
Division AD
Per unit
Price
- uvcAD
-screen cost
-uvpcAD
ucmAD
Status Quo
0
0
0
0
0
Accept Transfer
4000*PT
-4000* uvcAD
- 4000*TPmax
0
4,000*(PT - uvcAD - TPmax)
Buy Externally
4000*PT
-4000* uvcAD
-4000* 100
-4000*3
4,000*(PT - uvcAD -103)
Thus, Division B will be indifferent between accepting the transfer and buying
externally if TPmax = $103/s.

Division AD
Per unit
Price
- uvcAD
-screen cost
-uvpcAD
ucmAD
Status Quo
0
0
0
0
0
Accept Transfer
8,000*PT
-8,000* uvcAD
- 8,000*TPmax
0
8,000*(PT - uvcAD - TPmax)
Buy Externally
8,000*PT
-8,000* uvcAD
-8,000* 100
-8,000*3
8,000*(PT - uvcAD -103)
Thus, Division B, at any order size, will be indifferent between accepting the transfer
and buying externally if TPmax = $103/s.
There can be trade between divisions at the two order sizes:
At an order size of 4,000 screens the transfer price will be negotiated in TP [80,
103]
At an order size of 8,000 screens the transfer price will be negotiated in TP [97.5,
103]
c.
From the point of view of the shareholders, the divisions should transfer as many screens
as possible internally. For each screen that is transferred internally the company saves
the marketing cost the SD and the purchasing cost of the AD. Therefore, 8,000 screens
should be transferred internally. Therefore, it is goal congruent to let them negotiate.

They have a range of transfer prices at which they can trade.
Problem 1
Castaway Products uses a standard costing system to assist in the evaluation of operations. The
company has had considerable employee difficulties in recent months. To redress the situation,
management has hired a new production supervisor (Joe Simms). Simms has been on the job for
six months and has seemingly brought order to an otherwise chaotic situation.
The vice-president of manufacturing recently commented that Simms has really done the trick.
Joes team-building/morale-boosting approach has truly brought things under control. The vicepresidents comments were based on both a plant tour, where he observed a contented work force,
and review of a performance report that showed a flexible budget labor variance of $14,000F and a
flexible budget direct-material variance of $5,000U. The vice-president is especially impressed by
these variances, because they are less than 2% of the companys budgeted labor and direct-material
costs respectively. Additional data (that the VP did NOT see) follow:
Total completed production amounted to 20,000 units.
Castaway reported a direct-material price variance of $117,000F, approximately 10% of budgeted
material cost.
A review of the firms budgeted cost records found that each completed unit requires 2.75 hours of
labor at $14 per hour.
Castaways production actually required 42,000 labor hours at a total cost of $756,000.

Calculate Castaways direct-labor price and efficiency variances. Calculate the direct-materials
efficiency variance.
Actual Labor Cost

Actual
Hours
42,000
As if Budget
Actual
Rate
Actual
Hours
x
$18.00*
42,000
x
$756,000
$588,000
$168,000U
Direct-labor
rate variance
Flexible Budget
Standard
Rate
No need to calculate
$14.00
$182,000F**
Direct-labor
efficiency variance
Flexible Budget Labor Variance $14,000F
*$756,000 42,000 hours

** Flexible Budget Labor Variance = Direct labor rate variance + Direct labor efficiency variance = $14,000
Thus, we just need to calculate:
Direct labor efficiency variance
DL price variance:
DL efficiency variance:
= Flexible Budget Labor Variance - Direct labor rate variance

=14,000 (-168,000) = 182,000 F
$168,000 unfavorable
$182,000 favorable
DM efficiency variance = DM flexible budget variance DM price variance =

= - $5,000 $117,000 = - $122,000 = $122,000U

Evaluate Simms based on the direct-labor and direct-material variances. Does the vice-president
have a clear picture of what is going on? Given that you have more information than the vicepresident, can you give any alternative explanation to the variances? (Make sure you explain a
consistent story that fits the variances available and takes into account interactions between
variances.)
The student could say something about how the variance is larger than the report suggests or that
breaking them out gives more information
Castaway should be concerned. Although the combined variance of $14,000F is small, a more
detailed analysis reveals the presence of sizable, offsetting variances. Both the rate variance and
the efficiency variance are in excess of 21% of budgeted amounts ($770,000). A variance
investigation should be undertaken if benefits of the investigation exceed the costs. Put simply,
things are not going as smoothly as the vice-president believes.
A Plain interpretation of variances without interactions
The favorable efficiency variance means that the company is producing units by consuming fewer
hours than expected. This may be the result of the team-building/morale-boosting exercises, as a
contented, well-trained work force tends to be efficient in nature. However, another totally plausible
explanation could be that Castaway is paying premium wages (as indicated by the unfavorable rate
variance) to hire laborers with above-average skill levels.
Indicating something about interdependencies
There may be a relationship between the two variances. The favorable labor efficiency variance
may partially explain the unfavorable material quantity variance. That is, laborers may be rushing
through their jobs and using more material than standard.
Problem 2 Tuscany Statuary manufactures bust statues of famous historical figures. All statues are
the same size. Each unit requires the same amount of resources. The following data is from the
master budget for 2008:
Expected production and sales
Direct materials
Total fixed costs
5000 units
50,000 pounds
20,000 hours
$1,000,000
Budgeted input quantities, prices and unit costs follow for direct materials and direct labor.
Direct materials
Direct labor
Budgeted Input
Quantity
(per unit of output)
10 pounds
4 hours
Budgeted Price
Budgeted Unit Cost
$10 per pound

$40 per hour
$100
$160
During 2008, actual number of units produced and sold was 6,000. Actual cost of direct materials
used was $594,000, based on 54,000 pounds purchased at $11 per pound. Direct manufacturing
labor-hours actually used were 25,000, at the rate of $38 per hour. This resulted in actual direct
manufacturing labor costs of $950,000. Actual fixed costs were $1,005,000. There were no
beginning and ending inventories.
Problem 2, Part A. (20 points).

Calculate the (variable-cost) sales-volume variance and (variable-cost) flexible-budget variance
for direct materials and direct labor. Show and very clearly label your work.
Actual
Results
Units sold
Direct materials
FlexibleBudget
Variances
(1)
(2) = (1) (3)
a
6,000
0
$ 594,000
Direct manufacturing labor 950,000a

Fixed costs
1,005,000a
Total costs
$2,549,000
Flexible
Budget
SalesVolume
Variances
Static
Budget
(3)
(4) = (3) (5)
6,000
1,000 F
$ 6,000 F $ 600,000 b $100,000 U $ 500,000c

10,000 F
960,000d 160,000 U
800,000e
5,000 U 1,000,000a
0
1,000,000a
$11,000 F $2,560,000 $260,000 U $2,300,000
$11,000 F
$260,000 U
Sales-volume variance
$249,000 U
Static-budget variance
a
Given
$100 6,000 = $600,000
c
$100 5,000 = $500,000
d
$160 6,000 = $960,000
e
$160 5,000 = $800,000
b
(5)
5,000a
Problem 2, Part B. (20 points) Compute price and efficiency variances for direct
materials and direct labor. Show and very clearly label your work.
Actual
As If
Flexible
IA*NA*QA
IB*NA*QA
IB*NB*QA
$594,000a
$540,000b
$600,000c
Budget
Direct materials
$54,000 U
$60,000 F
Price variance
Efficiency variance
$6,000 F
$950,000a
$960,000f
$1,000,000e
$50,000 F
Price variance
$40,000 U
Efficiency variance
$10,000 F
a
54,000 pounds $11/pound = $594,000

54,000 pounds $10/pound = $540,000
c
6,000 statues 10 pounds/statue $10/pound = 60,000 pounds $10/pound =
$600,000
d
25,000 pounds $38/pound = $950,000
e
25,000 pounds $40/pound = $1,000,000
f
6,000 statues 4 hours/statue $40/hour = 24,000 hours $40/hour = $960,000
b
Problem 2, Part C. (20 points).

The company is organized in three departments: purchasing, production and marketing.
Recently, the purchasing manager and the production manager have been arguing about
quality vs. efficiency issues. Provide the manager of Tuscany Statuary with an idea as to
what may have caused and who might be responsible for the following variances as you
calculated them in Parts A and B:
i)
ii)
iii)
Sales volume variances

Direct materials price variance
Direct labors efficiency variance
The following are some of the possible interpretations of the resulting variances:
Direct materials unfavorable price variance may have been caused by the purchasing
department
(1) paying higher price than the standard for the period
(2) changing to a new vendor
(3) buying higher-quality materials
Direct materials favorable efficiency variance may have been caused by the production
department
(1) making employee/machinery working more efficiently and having less scrap and
waste materials
(2) buying better-quality materials. Notice that, since the direct materials flexible
budget variance is favorable, this interpretation would make the increase in
quality of direct materials a good decision of the purchasing department.
(3) changing the production process.
Direct labors favorable price variance may have been caused by the production
department
(1) changing the work force by hiring lower-paid employees
(2) changing the mix of skilled and unskilled workers
(3) not giving pay raises as high as anticipated when the standards were set for the
year
(4) having to pay less over-time due to a higher efficiency in the production process
Direct labors unfavorable efficiency variance may have been caused by the production
department
(1) changing the mix of skilled and unskilled workers. This interpretation is coherent
with the favorable labor price variance being caused with lower paid workers.
Overall, since the labor flexible variance is favorable, this would have been a
good decision of the production department. Nevertheless, one should also
consider the effects of these changes on the quality of the final product.
(2) The workforce was increased with unskilled workers to avoid paying overtime.
This would be consistent with the favorable labor price variance.
(3) changes of production process (learning something new takes time). This would
be consistent with a process change that reduces spoilage or rework and,
therefore, produces a favorable direct materials efficiency variance.
(4) different types of direct materials to work with. This could also be related to a
change of materials decided by the purchasing department.
(5) poor working conditions or poor attitudes on behalf of the workers. This might
be consistent with giving lower raises to the workforce and thereby obtaining a
favorable labor price variance.
Sales volume variances: all sales volume variance are unfavorable because volume
increased. This might be because the marketing department has did a better job than
expected in promoting sales, or because the marketing department did not forecast sales
accurately (or both). In any case, an unexpected high volume of sales may also be related
to the unfavorable labor efficiency and direct materials price variances because of rush
orders, stock-outs or capacity issues.

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Finance Practice Problems

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Problem 1

The following data pertain to the Western Division of Jordan Company:

Problem 1 Part A. (2 points) which investment(s) (if any) would Jordans

Free Cash Flow

Free Cash Flow

Problem 2. Part B (1.5 points)

Problem 2. Part C (1.5 points)

One year horizon

Slow Roasted Kona

Slow Roast Kona

Problem 1 Part A. (5 points)

Total budgeted overhead/cost driver = $2,600,000/$1,000,000 = $2.6 per DL cost

Problem 1 Part B. (20 points)

Problem 1 Part C. (10 points)

Problem 2 Part A (16 points)

Problem 2 Part B (8 points)

ABC Income Statement (2009)

Problem 2. Part C (6 points)

= $1,118 - ($378 + ($127 0.37) = $693

= $7,462 $1,506 $846 $375 $652 $495 $292 = $3,296

= $6,579 - $795 $726 $336 $596 $469 $267 = $3,390

= $9700 / [ ($3,296 + $3,390) / 2 ] = 2.90

= 7.14% 2.90 = 20.73% (0.0002 rounding error)

= $6 +$ 2,775 $1,506 = $1,275

2011 nonoperating return = ROE RNOA = 34.12% 20.73% = 13.39%

g. ROE>RNOA implies that Nordstrom is able to borrow money to fund operating

Problem 1 Part A. (2 points) which investment(s) (if any) would Jordans

Free Cash Flow

Free Cash Flow

Problem 2. Part B (1.5 points)

Problem 2. Part C (1.5 points)

One year horizon

Problem 1 Part A. (20 points)

Actual Labor Cost

Flexible Budget Labor Variance $14,000F

*$756,000 42,000 hours

= Flexible Budget Labor Variance - Direct labor rate variance

DM efficiency variance = DM flexible budget variance DM price variance =

Problem 1 Part B. (20 points)

Budgeted Unit Cost

$10 per pound

Problem 2, Part A. (20 points).

Direct manufacturing labor 950,000a

$ 6,000 F $ 600,000 b $100,000 U $ 500,000c

54,000 pounds $11/pound = $594,000

Problem 2, Part C. (20 points).

Sales volume variances

Problem 1 - Part A (1 point)

Problem 1 - Part B (2 points)

CIC is better off transferring 5,000 Super-chips to the Process-Control Division.

Another approach is to consider the difference in contribution margins of selling the

Problem 1 - Part C (2 points)

Order Size: 8,000 screens

Thus, Division A will be indifferent if

Order Size: 8,000 screens

should be transferred internally. Therefore, it is goal congruent to let them negotiate.

Problem 1 Part A. (20 points)

Actual Labor Cost

Flexible Budget Labor Variance $14,000F

*$756,000 42,000 hours

= Flexible Budget Labor Variance - Direct labor rate variance

DM efficiency variance = DM flexible budget variance DM price variance =

Problem 1 Part B. (20 points)

Budgeted Unit Cost