MGMT 201: Chapter 13 Notes
MGMT 201: Chapter 13 Notes MGMT 201
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This 3 page Class Notes was uploaded by Zach Weinkauf on Saturday April 23, 2016. The Class Notes belongs to MGMT 201 at Purdue University taught by David Scott in Spring 2016. Since its upload, it has received 24 views. For similar materials see Managerial accounting in Business, management at Purdue University.
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Date Created: 04/23/16
Chapter 13: Investment Centers and Transfer Pricing Investment Centers – the largest subunits within a big organization. One type of “Responsibility Center” Managers are held accountable for: o The investment center’s profit o The capital invested to earn that profit Invested Capital – assets, such as buildings and equipment, used in a subunit’s operations. Decentralization – decision-making is pushed down o Advantages: Allows organizations to respond more quickly to events. Uses specialized knowledge and skills of managers. Frees top management from day-to-day operating activities. o Challenge: Goal Congruence – getting managers of subunits to make decisions that achieve top management goals (instead of their own). Investment Center Evaluation o Return on Investment (ROI) = Income/Invested Capital ROI = Sales Margin x Capital Turnover Sales Margin = Income/Sales Revenue How much of each sales dollar becomes profit. Capital Turnover = Sales Revenue/Invested Capital Dollars of sales revenue generated by each dollar of capital invested in the division’s assets. Ways to Improve ROI: Increase Sales Price Decrease Expenses Lower Invested Capital o Residual Income (RI) = Investment Center Profit – Investment Charge Investment Charge = Investment Capital x Imputed interest rate Imputed Interest Rate = Investment Center’s minimum required rate of return Advantages: Residual Income encourages managers to make profitable investments that would be rejected by managers using ROI. o Economic Value Added (EVA) = After-tax Operating Income – Investment Charge Investment Charge = (Investment Center’s Total Assets – Current Liabilities) x Weighted Average Cost of Capital Weighted Average Cost of Capital = ((After-tax Cost of Debt x Market Value of Debt) + (Cost of Equity Capital x Market Value of Equity))/ (Market Value of Debt + Market Value of Equity) Tells us how much shareholder wealth is being created Ex. From Powerpoint: 1 - Weighted Average Cost of Capital = 1. (9% x (1 - 30%) x $40,000,000) +(12% x $60,000,000) = Answer 2. Answer/($40,000,000 + $60,000,000) = 0.0972 2nd- Investment Charge = ($45,000,000 - $600,000) x 0.0972 = $4,315,680 rd 3 – Economic Value Added = ($6,750,000 x (1 – 30%)) - $4,315,680 = $409,320 Transfer Pricing – the amount charged when one division sells goods/services to another division. o This price affects the profit measurement for both the selling division and the buying division. o A high transfer price results in high profit for the selling division and low profit for the buying division o A low transfer price has the opposite effect o Consequently, the transfer-pricing can affect the incentives of autonomous division managers as they decide whether to make the transfer. o Goal Congruence – the ideal transfer price allows each division manager to make decisions that maximize the company’s profit, while attempting to maximize his/her own division’s profit. o General Transfer Pricing Rule – Transfer Price = Additional Outlay cost per unit incurred because goods are transferred + Opportunity cost per unit to the organization because of the transfer. Scenario 1: No Excess Capacity General Rule – When the selling division is operating at capacity, the transfer price should be set at the market price. Scenario 2: Excess Capacity General Rule – when the selling division is operating below capacity, the minimum transfer price is the variable cost per unit. Conflicts may be resolved by: Direct intervention by top management. Centrally established transfer price policies. Negotiated transfer prices.