Willowbrook Company You are the Vice President of Operations for Willowbrook Com
ID: 2591937 • Letter: W
Question
Willowbrook Company
You are the Vice President of Operations for Willowbrook Company, a decentralized company that makes several varieties of drinks, making soft drinks, cider-based drinks, and coffee drinks. Each division is run as an investment center with the manager’s performance evaluation based on their division’s ROI. $160,000 in corporate costs are allocated to the divisions based on division sales. In addition, there are $210,000 in corporate costs which cannot reasonably be allocated to the divisions.
Willowbrook has the following data for this year:
Soft Drinks Division
Cider Division
Coffee Division
Sales
$500,000
$1,300,000
$800,000
# of units sold
250,000
430,000
160,000
Contribution margin
260,000
475,000
460,000
Direct fixed costs
59,520
377,620
231,900
Average net operating assets
$320,000
$800,000
$420,000
Weighted-average cost of capital
17%
17%
17%
Willowbrook Company has a target annual rate of return of 20 percent, and is subject to a 30% tax rate. The Soft Drinks Division was recently presented with an investment in a $105,000 piece of machinery that would save operating costs of $5,000 per year over a period of thirty years. The new machinery would replace a current piece of equipment that could be sold for $2,000 and has a book value of $50,000. The manager of the Soft Drinks Division, with full decision rights on the matter, decided against replacing the current equipment.
The CEO of Willowbrook, David Copperfield, heard about the investment opportunity and is confused about the outcome. From his initial conversations with the Soft Drinks Division’s manager, it sounded like a good investment.
Copperfield is also reconsidering its investment in cider-based drinks - in the three previous years, Cider has shown a net loss. When Copperfield launched the Cider product line four years ago, he gave the division manager until this year to come ‘out of the red’. 80% of the Cider division’s direct fixed costs could be avoided by discontinuing the product line. At this point, Willowbrook has not identified an alternate use for the Cider production space, and all three divisions are currently running at 80% of practical capacity.
Required:
Write your response in the form of a 1-2 page memo to David Copperfield, from the perspective of the VP of Operations, a position that oversees all three divisional managers. Include an attachment with your financial analyses, clearly showing your calculations and highlighting your answers. Note that presentation is part of the grade.
a. Create a multilevel income statement, showing the three divisional incomes and the corporate net income (for Willowbrook overall).
b. Calculate the ROI, residual income, and EVA for the new investment considered by the Soft Drinks Division.
c. Provide a differential analysis of lifetime costs of the Soft Drinks Division’s investment.
d. Did the Soft Drinks division manager make the ‘right’ decision (i.e., was it in Willowbrook’s overall best interest for the Soft Drinks division to reject the investment)? Explain your answer.
e. Recreate the multilevel income statement from requirement (a) showing the overall effect on net income if Willowbrook were to discontinue the Cider product line. Provide a recommendation on whether to discontinue the Cider product line.
f. Notice how the allocation of corporate overhead affects the Cider product line. Provide a recommendation on a different way to allocate corporate overhead.
Soft Drinks Division
Cider Division
Coffee Division
Sales
$500,000
$1,300,000
$800,000
# of units sold
250,000
430,000
160,000
Contribution margin
260,000
475,000
460,000
Direct fixed costs
59,520
377,620
231,900
Average net operating assets
$320,000
$800,000
$420,000
Weighted-average cost of capital
17%
17%
17%
Explanation / Answer
Answer (a) & (b) At 80% Capacity At 90% Capacity Sr no. Particulars Soft drink Division Cider division Coffee Division Total Total 1 Units 250000 430000 160000 2 Sale 500000 1300000 800000 2600000 2925000 3 Less:Variable cost 240000 825000 340000 1405000 1580625 4 Contribution 260000 475000 460000 1195000 1344375 5 Less: Fixed Cost a Direct Fixed cost 59520 377620 231900 669040 752670 b allocated fixed cost 30769 80000 49231 160000 180000 c Unallocated cost 210000 236250 90289 457620 281131 1039040 1168920 6 Earning before tax 169711 17380 178869 155960 175455 7 Less:tax 50913 5214 53661 46788 52636.5 8 Earning After tax 118798 12166 125208 109172 122819 Answer(c) Sr no. Particulars Soft drink Division 1 Saving in operating cost 5000 2 Saving in tax on sale of asset 12600 3 Incresae in WACC 17850 4 Net benefit -250 Answer(d) Yes as per above analysis the decision of manager was right Answer(e) As per above analysis the earning after tax of cider division is 12166 thus it is recommended to not to discontinue the same Answer(f) Fixed cost can be allocated on the basis of number of unit sold
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