Reference no: EM132564271

Question 1 - Company Epsilon is considering entering the active marketing advisory service and there has been much discussion regarding how much a marketing advisor should charge per hour of service. The company has budgeted to supply 500,000 hours of advisory service for the forthcoming year. Its variable cost is estimated at $25 per hour and its fixed costs are estimated at $500,000 for the forthcoming year. The company has been discussing whether to use a cost-plus approach or perhaps examining the demand levels. The marketing department has the following information on demand levels at different prices:

Price per hour - Demand in hours

$27 - 520,000

$28 - 500,000

$29 - 400,000

$30 - 300,000

$31 - 225,000

Required -

(a) Calculate the price per hour Company Epsilon should charge based on a cost-plus approach for pricing the service at full cost plus 15%.

(b) Considering the company can meet any demand level in the table above and that fixed costs will remain unchanged for all the preceding demand levels, what price per hour should the company charge?

(c) Explain whether the different approaches lead to a different or identical price per hours and which approach should the company choose for the active marketing advisory service.

Question 2 - Company Epsilon has two retail divisions, retail division #1 and retail division #2, which reported the following results for the year end of 2019. The required rate of return set for the retail divisions is 10%.

Results for the year end of 2019

Retail division #1 Retail division #2

Net operating income $5,000,000 $15,000,000

Average operating assets $30,000,000 $100,000,000

If no investment in made for 2020, both retail divisions are expected to maintain the same net operating income and average operating assets as of 2019. However, there is an opportunity in 2020 for Company Epsilon to invest in one of the two retail division. The investment would be of $15,000,000 and would generate additional net operating income of $2,400,000 per year.

Required -

(a) Which division had the higher return on investment (ROI) in 2019 and why?

(b) Which division had the higher residual income (RI) in 2019 and why?

(c) If the managers of the retail divisions are evaluated based on return on investment (ROI), will the managers want to invest in 2020 and why?

(d) If the managers of the retail divisions are evaluated based on residual income (RI), will the managers want to invest in 2020 and why?