Renoir Inc.

1) Prepare a report in which you assess the current profitability of the Soap Division.

In order to analyze the profitability of the soap division, we have to first calculate the current profit margins of each line. From our analysis we can see that the bar and perfume soap products are not profitable with their current volume-price relationship. We performed the break-even analysis for both the bar and perfume soap products with the objective of determining the minimum number of units that should be sold for each of the products to be profitable. The results indicate (see appendix 1) that 100,000 additional units of bar soap at $1.4 per unit are required to reach the break-even point. Using the current price of perfume soap the quantity needed to reach the break-even surpasses the capacity of the line by 204,000 units (more than double!).

With this analysis we can conclude that the company should revise bar and perfume volumes and prices because the current ones are not generating any profit. In fact, these lines are being subsidized entirely by the profit of the liquid soap. We will include an entire section with recommendations for improving profitability at the end of the report.

2) Include a recommendation with respect to the production of deodorant soap for Europe.

First at all, we have to emit an opinion about the method that was used to suggest the transfer price of the deodorant soap. According to the article "there are three main methods for determining transfer prices: Negotiated transfer prices, Market-based prices, Cost-based transfer price". In this case the policy of transfer pricing of Renoir is cost-based transfer price (full cost by 1.25) but its partner Company is suggesting a market-based price. In this specific case, negotiated transfer price seems the most convenient method because the seller party (Renoir) has no unused capacity (best reason to choose cost-based price) in fact, it will have to invest in a new line, additionally the seller party has no market for the product (best reason to choose market-based price) other than the purchase party (Europe), however, the purchase party has made it clear that there is no incentive for them to buy the deodorant for more than $2 per unit, because that is the market price of this product in France.

The deodorant soap would generate a 3.41% profit margin and improve the total profit margin of the soap division by 0.35% (see appendix 2). The return on investment deodorant soap for the first year would be 6% and by year 5 would be 13% (because of accumulated depreciation), these figures barely satisfies Renoir's corporate target of 12%. Even though the deodorant product generates certain profit, the profit margin is quite low which might represent risk for Renoir given the fact that the company doesn't have a market for the remaining volume and any small increase in cost would represent loses. There is also a potential risk associated to the investment, which is that by the end of year 5 the assets will have a remaining value of $150,000 which would represent a write-off for Renoir in the case that the contract is not renewed.

We recommend Renoir negotiate with its European partner to increase the volume to the full capacity of the line, and an increase on the transfer price based on the potential savings in corporate taxes for Europe.

The new question is, what price should be targeted?, we suggest negotiating the transfer price that will generate the corporate Return on Investment target (12%) in the first year, this price would be $2.08 per unit.

Although this analysis is being done from the accounting point of view, we think that is important to mention that there are other complementary ways to evaluate the Deodorant decision such as financial analysis, which include a series of test for evaluating investment such as net present value, payback and internal rate of return.

3) Discuss the issues raised by the soap division director concerning organizational structure, transfer pricing policy and performance evaluation.

To answer this question first at all we need to have a clear picture of what is the manager responsible for?. Currently the division is defined as an Investment Centre (according to the article, an investment centre is accountable for investment and profits) but in any part of the text is stated that the Division Director can invest whenever he wants without consultation. Is he autonomous regarding profits?, apparently yes, because is state in the text that he has to make the needed adjustment in the budget in order to reached an expected ROI of 12% which could be done either by increasing profit or decreasing invested capital, of these two the easiest one is estimate higher profit. Apparently for what we see this division looks like a profit centre rather than an investment centre if this were true the division should be evaluated by EBIT instead of by ROI. On the other hand, if the director is accountable