You are the Vice President of Operations for Willowbrook Company, a decentralize

Question

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. PLEASE SHOW THE WORK

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. PLEASE SHOW THE WORK

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.  PLEASE SHOW THE WORK

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

a)

Soft Drinks Division

Cider Division

Coffee Division

CORPORATE TOTAL

Sales

$500,000

$1,300,000

$800,000

2600000

# of units sold

250,000

430,000

160,000

840000

Contribution margin

260,000

475,000

460,000

1195000

Direct fixed costs

59,520

377,620

231,900

669040

NET INCOME

200480

97380

228100

525960

TAX @ 30%

60144

29214

68430

157788

NOPAT

140336

68166

159670

Average net operating assets

$320,000

$800,000

$420,000

1540000

b)

ARR = INCOME BEFORE TAX

/ AV ASSETS

X 1000

200480/320000

X100

= 62.65%

97380/800000 X 100

= 12.17%

228100/420000

X 100

= 54.3%

34.15%

b)   RESIDUAL INCOME=

OP ASSETS X COST OF CPAITAL

LESS OP INCOME

320K X 17%

= $$54400

200480

= $146,080

800k X 17%

= 136000

$ -233244

420k X 17%

=71400

$156700

c)    EVA

NOPAT LESS

CAPITAL X WACC

140336

68166

LESS

800k X 17%

136000

-67834

159670

420k X 17%

= 71400

= 88270

ONLY EVA IS POOR

Thus only Cider division has achieved< requirement of 20%

BUT IT HAS BEST SALES

BEST NUMBER OF UNITS

BEST CONTRIBUTION

Weighted-average cost of capital

17%

17%

17%

REPORT

To        : CEO

From   : VP

Re        : PERFORMANCE OF THREE SOFT DRINKS DIVISIONS

With reference to above, I wish to point the following features:

CIDER:   It should NOT BE DISCONTINUED

Even though it showed losses fro previous years it is now showing profits

Also it has the best sales/ best number of units sold and best contribution margin

D   Thus we need to focus on ‘controlling costs’ it will be out of red like this year

SOFT DRINKS INVESTMENT

Savings : 30 years x $ 5000= $$150,000

150000/105000 x 100 = 142% return

Thus it should not have been refused

F    CORPORATE COSTS

$210,000 if divided on the basis of sales ( if the effort is on sales)

Would be:

Soft drink   210,000/2600000 x 500 = 40384

Cider    1300/2600 x 210 = $105000 would end in a loss

Coffee     800/2600 x 210 = 64615

a)

Soft Drinks Division

Cider Division

Coffee Division

CORPORATE TOTAL

Sales

$500,000

$1,300,000

$800,000

2600000

# of units sold

250,000

430,000

160,000

840000

Contribution margin

260,000

475,000

460,000

1195000

Direct fixed costs

59,520

377,620

231,900

669040

NET INCOME

200480

97380

228100

525960

TAX @ 30%

60144

29214

68430

157788

NOPAT

140336

68166

159670

Average net operating assets

$320,000

$800,000

$420,000

1540000

b)

ARR = INCOME BEFORE TAX

/ AV ASSETS

X 1000

200480/320000

X100

= 62.65%

97380/800000 X 100

= 12.17%

228100/420000

X 100

= 54.3%

34.15%

b)   RESIDUAL INCOME=

OP ASSETS X COST OF CPAITAL

LESS OP INCOME

320K X 17%

= $$54400

200480

= $146,080

800k X 17%

= 136000

$ -233244

420k X 17%

=71400

$156700

c)    EVA

NOPAT LESS

CAPITAL X WACC

140336

• 320,000 X 17%
• 54400
• = 85936

68166

LESS

800k X 17%

136000

-67834

159670

420k X 17%

= 71400

= 88270

ONLY EVA IS POOR

Thus only Cider division has achieved< requirement of 20%

BUT IT HAS BEST SALES

BEST NUMBER OF UNITS

BEST CONTRIBUTION

Weighted-average cost of capital

17%

17%

17%

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