Solved: Willowbrook Company Case (Managerial Accounting)

You are the Vice President of Operations for Willowbrook Company, a decentralized company that makes several varieties of drinks, making soft drinks, cider-based drinks, and coffee drinks. Each division is run as an investment center with the manager’s performance evaluation based on their division’s ROI. In addition to the information below, there are $320,000 in corporate costs, of which $190,000 are allocated to the divisions based on the number of units sold at each division. These costs are due to employee benefits, which are billed at the corporate level. The remaining $130,000 in corporate costs cannot reasonably be allocated to the divisions. Willowbrook has the following data for this year: Soft Drinks Division Cider Division Coffee Division Sales $500,000 $1,300,000 $800,000 # of units sold 250,000 430,000 160,000 # of employees 540 200 360 Contribution margin 260,000 425,000 460,000 Direct fixed costs 59,520 377,620 231,900 Average net operating assets $320,000 $800,000 $420,000 Willowbrook Company has a target annual rate of return of 22 percent, a weighted-average cost of capital 16%, and is subject to a 30% tax rate. The Soft Drinks Division was recently presented with an investment in a $205,000 piece of machinery that would save operating costs of $5,000 per year over a period of thirty years. The new machinery would replace a current piece of equipment that could be sold for $2,000 and has a book value of $50,000. The manager of the Soft Drinks Division, with full decision rights on the matter, decided against replacing the current equipment. The CEO of Willowbrook, David Copperfield, heard about the investment opportunity and is confused about the outcome. From his initial conversations with the Soft Drinks Division’s manager, it sounded like a good investment. Copperfield is also reconsidering its investment in cider-based drinks - in the three previous years, Cider has shown a net loss. When Copperfield launched the Cider product line four years ago, he gave the division manager until this year to come ‘out of the red’. 80% of the Cider division’s direct fixed costs could be avoided by discontinuing the product line. At this point, Willowbrook has not identified an alternate use for the Cider production space, and all three divisions are currently running below capacity. Required: Write your response in the form of a 1-2 page memo to David Copperfield, from the perspective of the VP of Operations, a position that oversees all three divisional managers. Be sure to include all your financial analyses, clearly showing your calculations, to support your conclusions. a. Create a multilevel income statement, showing the three divisional incomes and the corporate net income (for Willowbrook overall). b. Calculate the annual ROI, residual income, and EVA for the new investment considered by the Soft Drinks Division (not for the division overall). c. Provide a differential analysis of lifetime costs of the Soft Drinks Division’s investment, using the techniques learned in this class. Ignore tax effects in your analysis. d. Did the Soft Drinks division manager make the ‘right’ decision (i.e., was it in Willowbrook’s overall best interest for the Soft Drinks division to reject the investment)? Explain your answer. Your answer from part b. should inform your evaluation. e. Recreate the multilevel income statement from requirement (a) showing the overall effect on net income if Willowbrook were to discontinue the Cider product line. Provide a recommendation on whether to discontinue the Cider product line. f. Notice how the allocation of corporate overhead affects the Cider product line. Provide a recommendation on a different way to allocate corporate overhead.