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Final Exam

ACCT 502

Summer B 2022

Problem I:  Curriculum Committee

As part of my job as a faculty member, I served on Olin’s Graduate Programs Curriculum Committee for many years.  This committee includes one faculty member from each academic area (accounting, finance, marketing, etc.), as well as a number of administrators (representing the Career Center, admissions, etc.).  Although a typical meeting is about half faculty and half administrative, only faculty members are voting members.  

The primary role of the committee is to approve new courses.  If a faculty member or a department wishes to add a new course, they put together a proposal, which usually takes the form of a syllabus, and bring it to the committee.  The committee asks questions and debates the merits of the course.  In about half of the cases, the new course will be approved.  In the other half, the committee will have unanswered questions (e.g., who is going to teach the new course?), or requests (e.g., talk to another department to make sure that there isn’t too much overlap between the new course and a specific existing course).  In these cases, a second proposal will be scheduled, and the course will almost certainly be approved the second time through.  Roughly 95% of all proposals are accepted, about half the first time through and half the second time through.

Sitting in one of these meetings a few years ago, it occurred to me that since the committee ultimately approves almost all requests, it wasn’t obvious that there was any significant value to the committee.  However, thinking about it more carefully, I realized that the committee actual serves several important functions.  Using our levers of control framework, please describe two functions that a committee such as this serves, even if it were to approve almost all requests.

Problem II: Milwaukee Grain Company

Milwaukee Grain Company has two divisions, which reported the following results for the most recent year.

1.  For each division, compute:

Return on Investment: Division A __________ Division B __________

Residual Income: Division A __________ Division B __________

2.  Milwaukee Grain Company is trying to decide between using return on investment and residual income to compare the two divisional managers.  Briefly (two-four sentences in total) give one argument in favor of each metric, relative to the other.

Problem III:  Weston Pharmaceuticals

Weston Pharmaceuticals VP of research is evaluating a research proposal for a new drug.  She believes that if pursued, and if successful, the proposal’s future benefits will be $500 million (which she estimates to have a present value of $200 million today).  However, both the cost and the success of the project are uncertain.  Regardless of the cost, she believes that the project has only a 25% chance of success – if it fails, Weston will still bear the entire cost, but will receive no benefits.  She believes that the cost of the project (at present value) will be:

Cheap project: $20 million with probability 30%

Moderate project: $40 million with probability 40%

Expensive project: $60 million with probability 30%

But the VP cannot now or later observe the actual cost of the project.  Assume that the head of the research team proposing the new drug knows the cost, and is able to use any additional funds budgeted.  The head of the research team does NOT know whether or not the project will be successful, but agrees that the project has a 25% chance of success.  Finally, assume that the VP of research will announce a budget cap for the new drug, which cannot be exceeded (so if the head of the research team knows that the project will cost more than the budget, the project will not be undertaken).

1. In the absence of a goal congruence problem (e.g., if the head of the research team and the VP of research were the same person), what budget cap would be set?  What would the expected net present value of the project be to Weston (including the possibility that it is not undertaken)?

2. Briefy (one or two sentences) explain the goal congruence problem between the VP of research and the head of the research team.

3. With the goal congruence problem, what budget cap should the VP of research set?  What is the expected net present value of the project to Weston (including the possibility that it is not undertaken)?

Problem IV:  Redstone Technology, Inc.

Redstone Technology, Inc. is an Irish company with a manufacturing subsidiary in Manchester, England.  Manchester currently produces and sells a highly specialized voltage reducer to aircraft manufacturers in England for €160 per unit.  Manchester has variable costs of €100 per unit, and Manchester can sell as many of these as it can produce.  England has a corporate tax rate of 40%.

Redstone’s corporate office is considering using the voltage reducer in a new satellite positioning system which would be produced in Dublin, Ireland.  The positioning system has an anticipated selling price of €290, and requires an additional €120 of variable manufacturing costs, as well as one voltage reducer.  Ireland has a corporate tax rate of 20%.  Redstone is suggesting a transfer price of €150 per voltage reducer.

Redstone is eager to introduce this new product; however, if the voltage reducers cannot be obtained from Manchester, the product will not be possible.  Assume that Dublin has excess capacity, so the new product can be produced without any opportunity cost.  The company pays divisional management bonuses based on divisional profit.

1.   Will Manchester’s divisional manager be happy with the new plan (and the €150 transfer price)?  Support your answer with calculations.

2.   Will Dublin’s divisional manager be happy with the new plan (and the €150 transfer price)?  Support your answer with calculations.

3.   Will Redstone as a whole be happy with the new plan (and the €150 transfer price)?  Support your answer with calculations.

4.   Assuming that the transfer price must be between €100 and €170, what transfer price would be most tax efficient from Redstone’s perspective, ignoring goal incongruence (e.g., if Redstone were completely centralized)?  

5. Assuming that the transfer price must be between €100 and €170, what transfer price would be most tax efficient from Redstone’s perspective, taking goal incongruence into account?  What is the cost (per voltage reducer) of goal congruence?  

Problem V:  Nova Building Supplies

Nova Building Supplies provides supplies and parts to construction firms throughout the United States.  Nova is divided into two segments, residential construction (mostly single-family homes) and commercial construction (e.g., office buildings).  The construction industry is largely local, so Nova is also organized into geographic regions.  Historically their strategy has been focused on high volume and low prices, but increased competition has begun to significantly erode their margins.  As a result, Nova has decided on a new sustainability strategy which will focus on products and procedures which reduce harm to the environment.  While it is expected that this strategy will increase costs, Nova believes that it will allow them to differentiate themselves from their competitors, leading to increased market share and higher margins.  They also expect that it will improve employee morale, which will increase employee productivity and at least partially offset the increases in costs.

As a test of this strategy, Nova rolled it out in two regions (Northern California and Louisiana), and collected the following data (from a fiscal quarter prior to the roll-out and a fiscal quarter one year later, which was six months after the roll-out).

1. Draw a simple strategy map for Nova’s NEW sustainability strategy, using, as much as possible, goals that can be measured by the metrics on the following page.  Briefly discuss the logic behind your strategy map.  For each objective on the strategy map, suggest one performance measure which you might use to measure it (most, if not all, should come from the list on the following page).  

(a) In millions of dollars.  

(b) This is a gross margin, computed as (sales minus cost of goods sold) divided by sales.

(c) This is an index that Nova set up as part of the new strategy to measure the increased costs as a result of greater sustainability practices. The before number is set to 100%, and the after number represents the increase in cost per unit produced after the new strategy.  Note that while the residential and commercial markets are separate, the products in the two markets are very similar.

(d) Based on surveys of customers (1 = very unwilling to recommend; 10 = very willing to recommend).

(e) Percentage of employees in the department one year before the start of the quarter, who were still  employed by Nova at the end of the quarter.

(f) Based on surveys of employees (1 = very unsatisfied; 10 = very satisfied).

(g) This is a labor efficiency variance (1.00 indicates that our employees take the budgeted amount of time authorized to complete the work that they are assigned; a number less than 1.00 indicates that they are more efficient than budgeted, while a number higher than 1.00 indicates that they are less efficient than budgeted).

(h) In thousands of dollars.  This represents incremental marketing spend to promote awareness of Nova’s new focus on sustainability.  Corporate’s plan is to spend approximately 1% of sales in each region.

(i) Based on GRI (Global Reporting Initiative) standards, this represents the extent to which Nova’s manufacturing facilities are actually sustainable (0=lowest level of sustainability, 1=highest level of sustainability).  Note that this is a firm-wide measure, and so is the same for all regions.

2. Based on the strategy map and the measures, what can you conclude about the effectiveness of Nova’s new sustainability strategy?  Be as specific as you can as to what part or parts of the strategy are effective or ineffective.  You should be able to do this without any formal statistics.