# ECON 1010 Lecture Notes - Lecture 1: Asset Turnover, Italian National Olympic Committee, Fixed Cost

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7 Feb 2016
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SOLUTIONS:
YORK UNIVERSITY
Faculty of Liberal Arts & Professional Studies:
Instructions:
A: This is a closed book examination and no collaboration is allowed.
B: There are five questions: answer them all in the examination booklets
provided.
C: You may write with a pencil or a pen.
D: Place photo identification on your desk during the examination to facilitate
verification.
E: Marks will be posted to the course website as soon as they are available.
F: You are allowed to use a simple calculator.
G: You are allowed to use a dictionary.
H: Show all workings.
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Question 1: (15 marks: allow about 25 minutes):
You have been hired by the President of Electric Motors & Computing Corp.
(EM&CC) to provide advice on 2 issues. EM&CC has a number of divisions,
each with their own manager.
The following information is taken from the 2013 accounting records of East
Coast Marketing, a division of EM&CC.
Sales \$12,000,000
Variable costs 4,000,000
Contribution margin \$ 8,000,000
Direct fixed costs 5,000,000
Segment income \$ 3,000,000
=========
At the beginning of 2013, East Coast Marketing had total assets of \$6,000,000.
At the end of 2013 total assets were \$4,000,000.
Required:
a: Calculate the asset turnover ratio, the profit as a percentage of sales and the
return on investment ratio: (9 marks).
Asset turnover ratio = Sales/assets
= \$12,000,000/(\$6,000,000 + \$4,000,00/2) = 2.4 X
Profit as % of sales = profit/sales * 100%
= \$3,000,000/\$12,000,000 * 100% = 25%
Return on investment ratio = Profit/assets * 100%
= \$3,000,000/(\$6,000,000 + \$4,000,00/2) =60%
b: The President wants to know how the compensation plan that is used to
provide annual pay increases to managers should relate to the overall goals and
objectives of EM & CC: (6 marks).
The compensation plan should be directly linked to the overall goals and
objectives of the company. Assume that compensation consists of a fixed salary
plus a variable component based on results. If the goal is to make a certain %
return on assets then variable compensation should kick in when that gaol has
been reached, but not before. If the goal is something else (such as market
share or growth) then the variable compensation should kick in when that goal
has bben reached, but not before.
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Question 2 (20 marks: allow about 35 minutes)
The Gasket Division is an autonomous division of Precision Parts Inc. It is
producing 120,000 gaskets per month, which represents full capacity utilization.
All its production is sold to outside buyers. The Rebuilt Engine Division of
Division. These are in various sizes and shapes, but one commonly used gasket
(type XL5) is being used to set the transfer price. The outside purchase price (by
Rebuilt engines) and selling price (by the gasket Division) of XL5 is \$7.50. The
Gasket Division’s cost estimates for XL5 are as follows:
Direct materials: \$2.00
Direct labour: 1.00
Variable selling costs: 1.80
Fixed selling costs: 0.80
The variable selling costs are mostly commission paid to sales representatives.
These would not be incurred on an internal sale.
Required: (5 marks each)
a) What would be a fair transfer price for the Gasket Division to supply
product XL5 to the Rebuilt Engine Division (explain why it is fair)?
As the Gasket Division is operating at full capacity the minimum price that they
could accept is their outside selling opportunity cost, less the variable selling cost
that would be avoided: \$7.50 - \$1.80 = \$5.70.
b) What would be a fair transfer price for the Rebuilt Engine Division to buy
product XL5 from the Gasket Division (explain why it is fair)?
As the Rebuilt Engine Division can buy these parts for \$7.50 externally, it would
be fair for them to be charged somewhere between \$5.70 and \$7,50, so that both
parties can share the benefit of an internal sale: say \$6.60 (mid-point.
c) Should the management of Precision Parts Inc. take any action in respect
of the transfer price or the sourcing of these gaskets, and if so, what and
why?
There is a range (\$5.70 to \$7.50) within which both parties should be able to
agree a transfer price that benefits them both and benefits the organization as a
whole: intervention should be unnecessary.
d) If the Gasket Division had excess capacity, in what ways would your
answers to (a) (b) and (c) above change?
Same answer as (c), but the range is larger (\$3.00 to \$7.50): again intervention
should be unnecessary.
In either (c) or (d) if they cannot agree a transfer price the company should
consider intervention to force an internal transfer at an imposed price.
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