Problem No. 1: The operating result of three divisions of X Ltd.

is given below:

Particulars Divisions
A B C
Sales 400000 400000 2000000
Less: Expenses 360000 200000 1800000
Segment profit contribution 40000 200000 200000
Segment assets 200000 800000 4000000
Determine the rate of return for these three divisions and rank these divisions assuming that company follows
investment center basis of performance evaluation.

Solution:

Rate of return of divisions

Particulars Divisions
A B C
Sales 400000 400000 2000000
Less: Expenses 360000 200000 1800000
Segment profit contribution 40000 200000 200000
Segment assets 200000 800000 4000000
Profit Margin = Profit / Sales x100 10% 50% 10%
Assets Turnover (Sales / Assets) x 100 2 0.50 0.50
Segment rate of return % = Profit Margin X Assets T/O 20 25 5
Comments:

In absolute terms, segment profit contributions are similar (Rs. 2 lakh) for division B and C. However, in relative terms,
division B performance is far batter than division C and the respective figures for profit margin being 50% and 10%. The
segment rate of return of Division B is higher than that of C.

Although A and C both have 10% as profit margin, A earned a 20% Return on investment as compared to Cs 5% because
the assets turnover ratio of A is 2 times, whereas that of C is only 0.50. Based on their segment rate of return on
investment, the three would be ranked B- 1st, A 2nd, C 3rd.

Problem No. 2

The operating results of a manufacturing company for the current year are given below:

Particulars Amount (Lakhs)

Sales (40000 units) 480
Less: Trade discount 24
Net sales 456
Less: Cost of sales
Material 144
Labor 126
Factory overheads 63
Administrative overheads 36
Selling and dist. 45
Total Cost 414
Profit 42
The following changes are anticipated during next year:

(a) Units to be sold to increase by 25%.

(b) Material price to increase by 15%.
(c) Labor charges to increase by 12%.
(d) Overheads- factory overheads will be limited to 65 lakhs , administrative and selling and distribution overheads
are estimated to increase by 10% and 15% respectively.
(e) Profit target for the year is Rs. 60 lakhs.

Calculate the selling price and present the budgeted operating results, for the next year.

Solution:

(a) Budgeted operating Income Statement

Particulars Amount (Lakhs)

Sales (50000 units) 600
Less: Trade discount (5%) 30
Net sales 570
Less: Variable Cost
Material 207
Labor 176.4
Contribution 186.60
Less: Factory overheads
Factory 65
Administrative 39.60
Selling & Dist 51.57
Net profit 30.25

(b) Calculation of selling price

Particulars Amount (Lakhs)

Net profit estimated 30.25
Additional profit desired 29.75
Profit desired 60.00
Contribution required (186.6 + 29.75) 216.35
Add: Variable Cost 383.40
Net sales 599.75
Add: Trade discount 31.57
Gross sales 631.32
Selling Price Per Unit (63132000 / 50000) 1262.64
Problem No. 3:

You are furnished with the following data relating to Arvind Ltd.

Centers Cash & Bank Inventories Receivable Fixed Assets Profit

A 10 20 30 90 30
B 15 20 25 65 12.5
C 05 10 20 50 8.5
The corporate cost of capital of capital relating to money invested in receivables and debtors is 6% post tax. The rate of
return required by the company for investing in fixed assets is 9% post tax. Calculate the ROI and EVA from the above
data and show the difference between the two methods of investment center evaluation.
Solution:

(a) Calculation of ROI

Centers Cash & Inventories Receivable Fixed Assets Total Budgeted ROI %
Bank Investment Profit
A 10 20 30 90 150 30 20
B 15 20 25 65 125 12.5 10
C 05 10 20 50 85 8.5 10
360 51 14.16

While calculating ROI show calculation in respective column of ROI, show formula below Table

(b) Calculation of EVA

Centers Profit Current WACC Required Fixed Assets WACC Required EVA
Assets Earnings Earnings
(C.A X WACC) (F.A X
WACC)
(1) (2) (3) (4) (5) (6) (7) (8) = (1) (4 + 7)
A 30 60 6% 3.6 90 9% 8.10 18.30
B 12.5 60 6% 3.6 65 9% 5.85 3.05
C 8.5 35 6% 2.1 50 9% 4.50 1.90
51 9.3 18.45 23.25

EVA = Profits (CA X WACC + FA X WACC)

A =30 (3.6 + 8.10) = 18.3 Lakhs

B =12.5 (3.6 + 5.85) = 3.05 Lakhs

C =8.5 (2.1 + 4.50) = 1.9 Lakhs

Total EVA of Company = Profit Capital Carges

= 51 23.25 = 27.75 Lakhs

Comments: There is no consistency between the ROI objective and cutoff rate in any of the investment center. The
actual EVA can be calculated and compared with the budgeted EVA. Thus, it is worthwhile noting that if any investment
center earns more than 9% on fixed assets and 6% on current assets, its EVA will increase. This will make the financial
decision rules of the investment center consistent with those of the company.
Problem No. 4:

A company has two divisions A nad B which are operated as profit centers. Division A has been selling a part of its
production to the division B at Rs. 200 per unit. Annual output of division A is 10000 units. Sales are made as follows:

Division B 4000 units

Outside customer 6000 units

Unit cost of Division A is as follows:

Fixed cost Rs. 75 per unit

Variable Cost Rs. 100 per unit

Total Cost Rs. 175 per unit

Division B has found that it can negotiate a contract to buy from outside suppliers at Rs. 150 per unit. Should division B
be allowed to purchase from outside? Can you suggest an alternative in this respect?

Solution:

Cash Flows Buy from outside Buy from Division B

Total Purchase cost Rs. 600000 ----
(4000 x 150)
Total cash outlay ---- Rs. 400000
(4000 x 100)
Fixed Cost (4000 x 75) Rs. 300000 Rs. 300000
Total Cash Outflow of company Rs. 900000 Rs. 700000

From the above calculation it is clear that company make total profit of Rs. 20000o if it buys form Division B.

So, it is suggestible that company should buy from outside

(Note: just expand this by putting more comments)