The Valve Division of Bendix, Inc, produces a small valve that is used by various companies as a component part in their production. Bendix, Inc., operates its divisions as autonomous units, giving its divisional managers great descretion in pricing and other decisions. Each division is expected to generate a mimimum required rate of return of at least 14% on its operating assets. The Valve Division has average operating assets of $700,000. The valves are sold for $5 each. Variable costs are $3 per valve, and fixed costs total $462,000 per year. The division has a capacity of 300,000 valves each year.
1.) How many valves must the Valve Division sell each year to generate the desired rate of return on its assets?
a.) What is the margin earned at this level of sales?
b.) What is the turnover at this level of sales?
2.) Assume that the Valve Division's current ROI equals the minimum required rate of 14%. In order to increase the division's ROI, the divisional manager wants to increase the selling price per valve by 4%. Market studies indicate that an increase in the selling price would cause sales to drop by 20,000 units each year. However, operating assets could be reduced by $50,000 due to decreased needs for accounts receivable and inventory. Compute the margin, turnover, and ROI if these changes are made.
3.) Refer to the original data. Assume again that the Valve Division's current ROI equals the minimum required rate of 14%. Rather than increase the selling price, the sales manager wants to reduce the selling price per valve by 4%. Market studies indicate that this would fill the plant to capacity. In order to carry the greater level of sales, however, operating assets would increase by $50,000. Compute the margin, turnover, and ROI if these changes are made.
4.) Refer to the original data. Assume that the normal volume of sales is 280,000 valves each year at a price of $5 per valve. Another division of the company is currently purchasing 20,000 valves each year from an overseas supplier, at a price of $4.25 per valve. The manager of the Valve Division has refused to meet this price, pointing out that it would result in a loss for his division:
Selling price per valve: $4.25
Cost per valve:
Fixed ($462,000/ 300,000 valves): $1.54 $4.54
Net loss per valve: $(0.29)
The manager of the Valve Division also points out that the normal $5 selling price barely allows his division to earn the required 14% rate of return. "If we take on some business at only $4.25 per unit, then our ROI is obviously going to suffer," he reasons, "and maintaining that ROI figure is the key to my future. Besides, taking on these extra units would require us to increase our operating assets by at least $50,000 due to the larger inventories and accounts receivable we would be carrying." Would you recommend that the Valve Division sel to the other division at $4.25? Show ROI computations to support your answer.
This solution explains how to calculate:
1) Expected rate of return and units produced to meet this rate.
2) Margin value based on sales
3) Turnover based on sales
4) Return on investment
These values are found multiple times during the course of four different scenarios.