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Appendix 12A
Key Concepts/Definitions
2.
Range of Acceptable
Transfer Prices
Upper limit is
determined by the
buying division.
Lower limit is
determined by the
selling division.
Grocery Storehouse
Assume the information as shown with respect
to West Coast Plantations and Grocery Mart
(both companies are owned by Grocery
Storehouse).
Grocery Storehouse
West Coast Plantation can provide supply of
oranges to Grocery Mart (a unit of Grocery
Storehouse)
Grocery Storehouse An
Example
The selling divisions (West Coast Plantations) lowest acceptable transfer
price is calculated as:
Variable cost
Total contribution margin on lost sales
Transfer Price
+
per unit
Number of units transferred
Grocery Storehouse An
Example
If West Coast Plantations has sufficient idle capacity (3,000 crates) to
satisfy Grocery Marts demands (1,000 crates), without sacrificing
sales to other customers, then the lowest and highest possible
transfer prices are computed as follows:
Selling divisions lowest possible transfer price:
Grocery Storehouse An
Example
If West Coast Plantations has no idle capacity (0 crates) and must
sacrifice other customer orders (1,000 crates) to meet Grocery Marts
demands (1,000 crates), then the lowest and highest possible
transfer prices are computed as follows:
Selling divisions lowest possible transfer price:
Grocery Storehouse An
Example
If West Coast Plantations has some idle capacity (750 crates) and
must sacrifice other customer orders (250 crates) to meet Grocery
Marts demands (1,000 crates), then the lowest and highest possible
transfer prices are computed as follows:
Selling divisions lowest possible transfer price:
The principles of
decentralization suggest
that companies should
grant managers autonomy
to set transfer prices and
to decide whether to sell
internally or externally,
even if this may
occasionally result in
suboptimal decisions.
This way top management
allows subordinates to
control their own destiny.
Ex 12A-1 Case A
DIVISION X
Capacity in units
200,000
200,000
$90
$13
DIVISION Y
Purchase price per unit now being paid to an outside
supplier
$86
40,000
Ex 12A-1 Case B
DIVISION X
Capacity in units
200,000
160,000
$75
$8
DIVISION Y
Purchase price per unit now being paid to an outside
supplier
$74
40,000
Ex 12A-2
Sako Companys Audio Division produces a speaker that is used by
manufacturers of various audio products. Sales and cost data on the
speaker follow:
Selling price per unit on the intermediate market
$60
$42
$8
Capacity in units
25,000
Sako Companyhas a Hi-Fi Division that could use this speaker in one
of its products. The Hi Fi Division will need 5000 speakers per year. It
has received a quote of $57 per speaker form another manufacturer.
Sake Company evaluates division managers on the basis of divisional
profits.
Ex 12A-3
Division A manufactues electronic circuit boards. The boards can be
sold either to division B of the same company or to outside customers.
Last year, the following activity occurred in Division A.
Selling price per circuit board
$125
$90
20,000
16,000
Sold to Division B
4,000
Ex 12A-3
Selling price per circuit board
$125
$90
20,000
16,000
Sold to Division B
4,000
$53,690 $0
($17,000 + $27,400)/2
= $2.42
Price-Earnings Ratio
Price-Earnings
Ratio
Price-Earnings
Ratio
= 8.26 times
Dividend
Payout Ratio
$2.00
$2.42
= 82.6%
= 10.00%
Return on
=
Total Assets
Return on Common
Stockholders Equity
Return on Common = Net Income Preferred Dividends
Stockholders Equity
Average Stockholders Equity
Return on Common =
$53,690 $0
= 25.91%
Stockholders Equity
($180,000 + $234,390) 2
This measure indicates how well the
company used the owners
investments to earn income.
Financial Leverage
Financial leverage results from the difference between the rate of
return the company earns on investments in its own assets and the
rate of return that the company must pay its creditors.
Quick Check
Quick Check
$234,390
27,400
= $ 8.55
$234,390
27,400
= $ 8.55
Learning Objective 3
Compute and interpret
financial ratios that would
be useful to a short-term
creditor.
Working Capital
The excess of current assets
over current liabilities is known
as working capital.
Working capital is not
free. It must be
financed with longterm debt and equity.
Working Capital
Current Ratio
Current
Ratio
Current Assets
Current Liabilities
Current Ratio
Current
Ratio
Current Assets
Current Liabilities
Current
Ratio
$65,000
$42,000
1.55
Quick Assets
Current Liabilities
$50,000
$42,000
= 1.19
Sales on Account
Average Accounts Receivable
Accounts
$494,000
Receivable =
= 26.7 times
($17,000 + $20,000) 2
Turnover
This ratio measures how many
times a company converts its
receivables into cash each year.
365 Days
Accounts Receivable Turnover
365 Days
26.7 Times
= 13.67 days
Inventory Turnover
Inventory
Turnover
Inventory Turnover
Inventory
Turnover
Inventory
Turnover
Average
=
Sale Period
365 Days
Inventory Turnover
365 Days
12.73 Times
= 28.67 days
Learning Objective 4
Compute and interpret
financial ratios that would
be useful to a long-term
creditor.
$84,000
= 11.51 times
$7,300
Debt-to-Equity Ratio
Debtto
Total Liabilities
Equity =
Stockholders Equity
Ratio
Debt-to-Equity Ratio
Debtto
Total Liabilities
Equity =
Stockholders Equity
Ratio
Debtto
Equity =
Ratio
$112,000
$234,390
= 0.48
Exercises
Exercise: 16-7, 16-8, 16-9 and 16-10.