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1 September, 04:14

Deborah Lewis, general manager of the Northwest Division of Berkshire Co., has significant authority over pricing decisions as well as programs that involve cost reduction/control. The data that follow relate to upcoming divisional operations:

Average invested capital: $15,000,000

Annual total fixed costs: $3,900,000

Variable cost per unit: $80

Number of units expected to be sold: 120,000

Assume the unit selling price is $132 and that Berkshire has a 16% imputed interest charge.

Top management will promote Deborah to corporate headquarters if her division can generate $200,000 of residual income (RI). If Deborah desires to move to corporate, what adjustment must the division do to the amount of annual total fixed costs?

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  1. 1 September, 04:31
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    The revised fixed costs = $3,640,000

    Explanation:

    Calculation of Residual Income:

    Residual Income = Net income - (Invested capital * Minimum required rate of return)

    Net Income = Sales - Variable costs - Fixed costs

    Net Income = (120,000*132) - (120,000*80) - 3,900,000

    Net Income = $2,340,000

    Invested capital = $15,000,000

    Minimum required rate of return = 16%

    Therefore, residual income = $2,340,000 - ($15,000,000 * 16%)

    = - $60,000

    Hence, adjustment to be made to the amount of fixed costs so that residual income becomes $200,000 = $200,000+$60,000 = $260,000

    Therefore, revised fixed costs = $3,900,000 - $260,000 = $3,640,000
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