range of lifestyle footwear styles

Vans produces a range of lifestyle footwear styles. The following question presents hypothetical data concerning the transfer of rubber from Vans’ Rubber Department to the firm’s Assembly Department.

Beyond supplying other internal departments, the Rubber Department can also sell rubber to external customers for $2.00/kg.

Relevant cost data for each department is supplied below.

Rubber Department
(price per kg of Rubber)
Assembly Department
(price per unit)
Market price $2.00 $130.00
Direct Materials $1.00 $35.00*
Direct Labour $0.20 $20.00
Variable Overhead $0.10 $5.00
Fixed Overhead $0.10 $4.00

*Does not include the cost of rubber.

Required

  1. Illustrate how the price for internally transferred rubber could be set using negotiation between the Rubber and Assembly Department managers. Identify and discuss the likely transfer price range and how this would impact the contribution margins of the respective departments
  2. Provide and discuss three examples which illustrate how the use of transfer prices based on cost-plus pricing could be used for rubber transfers. Ensure that these examples effectively illustrate how cost-plus pricing is influenced by the cost base and the markup
  3. Assume that the transfer price for rubber was set using the market price. If the Assembly Department was approached by an external supplier offering to supply rubber for $1.20/kg, what would be in the best financial interests of the Rubber Department? From a financial standpoint, would using the external supplier be in the best interests of the firm as a whole? What other factors should be considered by the firm in evaluating this proposal?
  4. Provide and discuss examples which illustrate how the general transfer price rule could be used for rubber transfers. Which of the options provided would be preferred by each department?
  5. Identify and discuss the most appropriate method of setting a transfer price for rubber in this situation

Ensure that your answers for the above are discussed and supported by relevant calculations/workings. All calculations must be performed in Excel.

Question 2 – Capital Investment Analysis

The management team of Accent Group Limited have received a proposal from the manager of Hype DC. This proposal concerns a major upgrade to Hype DC’s stores to improve the customer experience. Key details relating to this proposal include:

  • The initial cost will be $22 million. This cost will be depreciated using the straight line method over the 5 year life of the upgrade.
  • During year 1, the firm will increase marketing costs by $2.0 million to promote the store upgrades.
  • Over the five year life of the project, it is expected that the upgrade will increase the firm’s sales by $18 million per year. On average, cost of sales is 45% of revenue.
  • The firm will need to higher additional staff over the life of the project to help to deal with the increased sale volume. In year 1, the firm’s staffing costs will increase by $1.0 million. These costs will increase by 3.5% p.a.
  • The upgrade is expected to increase the firm’s energy costs by $500,000 in year 1. This increase will be ongoing across the life of the project and will increase by 6% p.a.
  • Upgraded stores will include an old shoe recycling drop off zone.  This recylcing program will cost $75,000 in year 1. These costs will increase by 2% p.a.
  • At the end of year 3, the firm will spend $1.5 million on a minor refurbishment to the stores.

The firm’s tax rate is 30%. The firm requires a 16% required rate of return on all potential investments.

Required

In relation to the above proposal:

  1. Calculate the annual after tax cash flows and annual after tax profit
  2. Calculate the payback period .
  3. Calculate the net present value
  4. Calculate the internal rate of return
  5. Calculate the accounting rate of return
  6. Provide an overview of the key environmental and social factors that the firm should consider in evaluating the proposal
  7. Based on an assessment of the above and other factors, discuss whether the firm should go ahead with the proposal
  8. Discuss how sensitive your recommendations are to changes in assumptions in regards to the financial impact of the new capital investment. In your discussion, include examples which illustrate how changes to at least two assumptions impact the financial analysis

Ensure that your answers for the above are discussed and supported by relevant calculations/workings.

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