Reference no: EM132944080
Question - Lieme Corporation sells appliances through two divisions: Household Professional. The company's estimated 2021 income statement, by division, is below:
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Household Division
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Professional Division
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Total
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Sales
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90,000,000
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$7,000,000
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$97,000,000
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Variable Costs
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75,000,000
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$5,500,000
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$80,500,000
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Contribution Margin
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$15,000,000
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1,500,000
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16,500,000
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Divisional Fixed Costs
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13,000,000
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700,000
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13,700,000
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Division Margin
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2,000,000
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800,000
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2,800,000
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Allocated corp-level fixed costs
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1,500,000
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900,000
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2,400,000
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Net income (loss)
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$500,000
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(100,000)
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400,000
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Average net operating assets for Household Division is $11,300,000, and average net operating assets for Professional Division equal $2,280,000.
The company uses a company-wide required annual rate of return of 15%. Early in 2021, an internal consulting project identified identical cost-reduction opportunities at both divisions. For each division, this would require a one-time investment of $180,000; annual cost reduction at each division would equal $40,000. Answer the following four questions:
1. From the point of view of the company's owners, should the Household Division make the cost-reduction investment? From the point of view of the company's owners, should the Professional Division make the cost-reduction investment? Provide quantitative justification for your answer.
2. Top manager of each division is compensated based on that division's ROI (computed using that division's Division margin and divisional average net operating assets). Will the top manager of the Household Division make the cost-reduction investment? Will the top manager of the Professional Division make the cost-reduction investment? Provide quantitative justification for your answers.
3. The company is considering changing divisional managers' incentive plans. If the changes are made, top manager of each division would be compensated based on divisional residual income (instead of divisional ROI). Each division's residual income would be computed using that division's Division margin and divisional net operating assets. What is the Household Division's estimated 2021 residual income? What is the Professional Division's estimated 2021 residual income?
4. If divisional managers' incentive plans are changed as described in part 3 above, will the top manager of the Household Division make the cost-reduction investment? Will the top manager of the Professional Division make the cost-reduction investment? Provide quantitative justification for your answers.
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