Deck 12: Performance Evaluation and Decentralization

Question 1

In calculating residual income, the minimum rate of return is set by top management and is the same as the hurdle rate used for return on investment.

Answer 1

True

Question 2

Decreasing inventories leads to a reduction in return on investment (ROI).

Answer 2

False

Question 3

The direct comparison of the performance of two different investment centres is difficult using return on investment because return on investment is an absolute measure.

Answer 3

False

Question 4

Return on investment (ROI) is the most common measure of performance for a revenue centre.

Question 5

Economic value added (EVA) can be calculated by multiplying margin by turnover.

Question 6

The use of residual income encourages managers to accept any project that earns below the minimum rate.

Question 7

A production department within the factory, such as assembly, is an example of a profit centre.

Question 8

The after-tax operating income reduced by the total annual cost of capital is equal to the economic value added.

Question 9

Using return on investment to calculate residual income, the dollar cost of capital employed is the actual percentage cost of capital multiplied by the total capital.

Question 10

In a centralized company, overall profit margins can mask inefficiencies within the various subdivisions.

Question 11

A key feature of economic value added (EVA) is that it emphasizes after-tax operating income and the actual cost of capital.

Question 12

Turnover is the ratio of operating income to sales.

Question 13

By centralizing the operating decisions, central management has more freedome to engage in strategic planning and decision making.

Question 14

A manager assessing an investment using return on investment may make a different decision than had the manager assessed the Investment using residual income.

Question 15

Unlike ROI, residual income can encourage a short-run orientation.

Question 16

The practice of delegating decision-making authority to lower levels of management in a company is called centralization.

Question 17

Residual income is sometimes used to overcome the tendency of ROI to discourage investments that are profitable for the company but that lower the division's ROI.

Question 18

Decentralization is usually achieved by creating units called divisions.

Question 19

Economic value added (EVA) is similar to ROI in that it links net income to capital employed.

Question 20

Residual income = Operating income - (Minimum rate of return x Average operating assets)

Question 21

Which of the following is NOT a reason for decentralization?

A) focusing of central management
B) exposing segments to market forces
C) ease of gathering and using local information
D) allows all decisions to be made at the top

Question 22

Top management usually sets the transfer pricing policy, but the dicisions still decide whether or not to transfer.

Question 23

The selling division would never agree to a transfer price below its full manufacturing cost.

Question 24

In the negotiated transfer pricing, the buying division sets the ceiling (maximum possible transfer price) for the bargaining range.

Question 25

The actual transfer price nets out for the company as a whole in that total pre-tax income for the company is the same regardless of transfer price.

Question 26

Basically, EVA is residual income with the cost of capital equal to the minimum rate of return for the firm.

Question 27

In which of the following responsibility centres is a manager responsible only for sales?

A) a cost centre
B) a profit centre
C) a revenue centre
D) an investment centre

Question 28

Along which of the following lines are divisions in a decentralized company NOT created?

A) geographical
B) alphabetical by product line
C) types of goods or services produced
D) type of responsibility given to divisional manager

Question 29

Transfer pricing is a complex and often emotionally charged issue.

Question 30

Transfer pricing can affect the level of after-tax profits earned by a multinational company.

Question 31

The market price is always the best transfer pricing policy.

Question 32

When a product is transferred at market price, the transfer will optimize both divisional and company-wide profits.

Question 33

What is the decision-making approach that allows managers at lower levels to make and implement key decisions pertaining to their areas of responsibility?

A) decentralization
B) controllable accounting
C) responsibility accounting
D) optimal strategic accounting

Question 34

In negotiated transfer pricing, the selling division sets the ceiling (maximum possible transfer price) for the bargaining range.

Question 35

Transfer pricing decisions may harm the company as a whole.

Question 36

A transfer price is the price charged for a component by the selling division to the buying division of the same company.

Question 37

Which responsibility centre designation would be used for a production manager?

A) a cost centre
B) a profit centre
C) a revenue centre
D) an investment centre

Question 38

Transfer pricing does NOT affect divisional profits.

Question 39

Which term refers to the practice of delegating decision-making authority to the lower levels of management in a company?

A) authorization
B) centralization
C) decentralization
D) hierarchy flattening

Question 40

Why is decentralization frequently chosen by companies?

A) It allows higher management to make all decisions.
B) It allows for training and motivation of local managers.
C) It protects segments of the company from competitive pressures.
D) It allows higher management to gather local information to make better decisions.

Question 41

How is margin calculated?

A) operating income/sales
B) sales/average operating assets
C) average operating assets/operating income
D) operating income/average operating assets

Question 42

Suppose the margin of 0.2 stayed the same and the turnover ratio of 4.0 increased by 10%. What would be the effect on the ROI?

A) It would decrease by 10%.
B) It would remain the same.
C) It would increase by 10%.
D) It would increase by 15%.

Question 43

In which of the following responsibility centres is a manager responsible for both revenues and costs?

A) a cost centre
B) a profit centre
C) a revenue centre
D) an investment centre

Question 44

A segment of Syntex, Inc. manufactures and sells blankets. The various models of blankets are produced in a single factory using stable technology. They are sold by the sales department, which is also located in the factory. What centre is most probably used to account for this segment?

A) a cost centre
B) a profit centre
C) a revenue centre
D) an investment centre

Question 45

Last year, Western Division had a ROI of 15%. The manager of the Western Division is considering an additional investment for the coming year. What step will the manager likely choose to take?

A) accept the investment as long as its ROI is positive
B) reject the investment if it returns less than 15% ROI
C) reject the investment if it returns more than 15% ROI
D) accept the investment as long as it provides positive operating income

Question 46

In which of the following responsibility centres is a manager responsible for revenues, cost, and investment?

A) a cost centre
B) a profit centre
C) a revenue centre
D) an investment centre

Question 47

Suppose the operating asset turnover ratio increased by 35% and the margin increased by 25%. What would be the effect on the divisional ROI?

A) It would decrease by 60%.
B) It would decrease by 50%.
C) It would increase by 20%.
D) It would increase by 69%.

Question 48

SkyJet Airways has three divisions, the Western Division, the Eastern Division, and the Northern Division. The manager of the Western Division had wanted to purchase replacement airplanes for the division. However, he decided against it because, although revenues would increase and the new planes would be less expensive to operate, the initial cost of the planes was quite large. What centre is most probably used to account for the Western Division?

A) a cost centre
B) a profit centre
C) an investment centre
D) a revenue centre

Question 49

Suppose the International Division of National Products Company had a turnover ratio of 5.2 and a margin of 0.10. What would be the return on investment?

A) 23.8%
B) 38.0%
C) 52.0%
D) 420.0%

Question 50

Alpha Division
Alpha Division had the following information: $$\begin{array} { l l } \text { Asset base in Alpha Division } & \$ 800,000 \\\text { Net income in Alpha Division } & \$ 100,000 \\\text { Cost of capital } & 12 \% \\\text { Target ROI } & 15 \% \\\text { Margin for Alpha Division } & 20 \%\end{array}$$

-Refer to Alpha Division. Suppose the asset base is decreased by $200,000, with no other changes. What would be the return on investment?

A) 16.7%
B) 62.5%
C) 100.0%
D) 600.0%

Question 51

Which positive result does the use of return on investment (ROI) encourage managers to focus on?

A) operating efficiency
B) exclusively expenses
C) the relationship between expenses and investment
D) the efficient use of resources in generating income

Question 52

Ding Company had operating income of $140,000, sales of $437,500, and turnover of 0.5. What is Ding's ROI?

A) 16%
B) 32%
C) 50%
D) 64%

Question 53

What is an advantage of the ROI performance measure?

A) It encourages managers to focus on the short run at the expense of the long run.
B) It encourages managers to focus on the relationship among revenues, expenses, and investment.
C) It produces a narrow focus on divisional profitability at the expense of the profitability of the overall firm.
D) It discourages managers from investing in projects that would decrease divisional ROI but increase the profitability of the company as a whole.

Question 54

The manager of a division is displeased with the ROI of the division. What would increase ROI (holding everything else constant)?

A) increasing sales
B) increasing costs
C) increasing investment
D) decreasing operating income

Question 55

How is turnover calculated?

A) operating income/sales
B) sales/average operating assets
C) operating income/average operating assets
D) average operating assets/operating income

Question 56

How is return on investment (ROI) calculated?

A) operating income/sales
B) sales/average operating assets
C) operating income/average operating assets
D) average operating assets/operating income

Question 57

What is NOT an advantage of ROI?

A) It encourages cost efficiency.
B) It discourages excessive investment in operating assets.
C) It encourages managers of departments with high ROIs to invest in average ROI projects.
D) It encourages managers to pay careful attention to the relationships among sales, expenses, and investment.

Question 58

What is a disadvantage of a focus on return on investment?

A) It can encourage managers to focus on cost-cutting efforts.
B) It can encourage managers to cut inventories and reduce overall investment.
C) It can encourage managers to focus on the long run at the expense of the short run.
D) It can produce a narrow focus on divisional profitability at the expense of profitability for the overall firm.

Question 59

Sentenal Company had income of $20,000, average assets of $200,000, and sales of $80,000. What is Sentenal's ROI?

A) 0.4%
B) 10%
C) 20%
D) 25%

Question 60

Suppose the operating asset turnover increased by 75% and the margin increased by 50%. What would be the percentage increase in the ROI?

A) 25.0%
B) 75.0%
C) 100.0%
D) 162.5%

Question 61

Condor Company
Condor Company provided the following information for last year: $\begin{array}{ll}\text { Operating income } & \$ 60,000 \\\text { Sales } & \$ 240,000 \\\text { Beginning operating assets } & \$ 440,000 \\\text { Ending operating assets } & \$ 450,000\end{array}$

-Refer to Confor Company. What was the company's return on investment?

A) 0.10
B) 0.13
C) 0.32
D) 0.50

Question 62

Borraw Company
The following information pertains to the three divisions of Borraw Company: $\begin{array}{lll}&\text { Division } A & \text { Division } B\\\text { Sales } & ? & 1,250,000 \\\text { Net operating income } & \$ 25,000 & \$ 75,000 \\\text { Average operating assets } & ? & ? \\\text { Rebum on investment } & 20 \% & 15 \% \\\text { Margin } & 0.05 & ? \\\text { Tumover } & ? & ? \\\text { Target ROI } & 12 \% & 10 \%\end{array}$

-Refer to Borraw Company. What are the average operating assets for Division A?

A) $5,000
B) $25,000
C) $125,000
D) $208,333

Question 63

The Seasonal Division of The Hudson Bay Department Store had a net income of $660,000, a net asset base of $5,000,000, and a required rate of return of 10%. Sales for the period totalled $4,000,000. What was the residual income for the period?

A) $80,000
B) $160,000
C) $360,000
D) $480,000

Question 64

Gamma Division
The manager of Gamma Division projects the following for next year: $$\begin{array} { l l } \text { Sales } & \$ 100,000 \\\text { Operating income } & \$ 30,000 \\\text { Operating assets } & \$ 200,000\end{array}$$ The manager can invest in an additional project that would require $30,000 investment in additional assets and would generate $4,200 of additional income. The company's minimum rate of return is 12%.

-Refer to Gamma Division. What is the residual income without the additional investment?

A) $4,200
B) $6,000
C) $6,600
D) $24,000

Question 65

Borraw Company
The following information pertains to the three divisions of Borraw Company: $\begin{array}{lll}&\text { Division } A & \text { Division } B\\\text { Sales } & ? & 1,250,000 \\\text { Net operating income } & \$ 25,000 & \$ 75,000 \\\text { Average operating assets } & ? & ? \\\text { Rebum on investment } & 20 \% & 15 \% \\\text { Margin } & 0.05 & ? \\\text { Tumover } & ? & ? \\\text { Target ROI } & 12 \% & 10 \%\end{array}$

-Refer to Borraw Company. What are the average operating assets for Division B?

A) $75,000
B) $187,500
C) $500,000
D) $1,250,000

Question 66

When using economic value added (EVA) to calculate residual income, what is the formula for the cost of capital employed?

A) the actual percentage cost of capital × the total capital employed
B) the standard percentage cost of capital × the total capital employed
C) the actual percentage cost of capital × the average capital employed
D) the standard percentage cost of capital × the average capital employed

Question 67

What is the variable set by top management when calculating residual income?

A) the hurdle rate
B) the operating income
C) the actual operating assets
D) the average operating assets

Question 68

Which of the following is an absolute dollar measure rather than a percentage?

A) percentage of sales
B) return on investment
C) division return on investment
D) economic value added (EVA)

Question 69

Condor Company
Condor Company provided the following information for last year: $\begin{array}{ll}\text { Operating income } & \$ 60,000 \\\text { Sales } & \$ 240,000 \\\text { Beginning operating assets } & \$ 440,000 \\\text { Ending operating assets } & \$ 450,000\end{array}$

-Refer to Condor Company. What was the company's margin?

A) 0.10
B) 0.16
C) 0.25
D) 0.50

Question 70

What is the price the selling division charges for a component purchased by the buying division of the same company?

A) market price
B) transfer price
C) cost-based price
D) economic value added price

Question 71

What is the formula for calculating economic value added (EVA)?

A) margin - total annual cost of capital
B) operating income - average cost of capital
C) operating income - total annual cost of capital
D) operating income - taxes and the total annual cost of capital

Question 72

Gamma Division
The manager of Gamma Division projects the following for next year: $$\begin{array} { l l } \text { Sales } & \$ 100,000 \\\text { Operating income } & \$ 30,000 \\\text { Operating assets } & \$ 200,000\end{array}$$ The manager can invest in an additional project that would require $30,000 investment in additional assets and would generate $4,200 of additional income. The company's minimum rate of return is 12%.

-Refer to Gamma Division . What will happen to the company if the manager invests in the additional project?

A) ROI of the division will increase.
B) Average investment for will decrease.
C) Residual income of the division will increase.
D) There will be no impact on ROI or residual income.

Question 73

Gamma Division
The manager of Gamma Division projects the following for next year: $$\begin{array} { l l } \text { Sales } & \$ 100,000 \\\text { Operating income } & \$ 30,000 \\\text { Operating assets } & \$ 200,000\end{array}$$ The manager can invest in an additional project that would require $30,000 investment in additional assets and would generate $4,200 of additional income. The company's minimum rate of return is 12%.

-Refer to Gamma Division. What is the residual income with the additional project?

A) $4,200
B) $6,000
C) $6,600
D) $27,600

Question 74

How is residual income calculated?

A) operating income/(ROI × average operating assets)
B) operating income - (ROI × average operating assets)
C) operating income/(minimum rate of return × average operating assets)
D) operating income - (minimum rate of return × average operating assets)

Question 75

Borraw Company
The following information pertains to the three divisions of Borraw Company: $\begin{array}{lll}&\text { Division } A & \text { Division } B\\\text { Sales } & ? & 1,250,000 \\\text { Net operating income } & \$ 25,000 & \$ 75,000 \\\text { Average operating assets } & ? & ? \\\text { Rebum on investment } & 20 \% & 15 \% \\\text { Margin } & 0.05 & ? \\\text { Tumover } & ? & ? \\\text { Target ROI } & 12 \% & 10 \%\end{array}$

-Refer to Borraw Company. What is the turnover for Division B?

A) 0.150
B) 1.500
C) 2.500
D) 6.670

Question 76

Condor Company
Condor Company provided the following information for last year: $\begin{array}{ll}\text { Operating income } & \$ 60,000 \\\text { Sales } & \$ 240,000 \\\text { Beginning operating assets } & \$ 440,000 \\\text { Ending operating assets } & \$ 450,000\end{array}$

-Refer to Condor Company. What was the company's turnover ratio?

A) 0.10
B) 0.16
C) 0.32
D) 0.54

Question 77

Economic value added is residual income with the cost of capital equal to which of the following?

A) the firm's actual cost of capital
B) the firm's average cost of capital
C) the firm's standard cost of capital
D) the firm's budgeted cost of capital

Question 78

Zorro Company
The following information pertains to the three divisions of Zorro Company: $\begin{array}{llll}&\text { Division } A &\text { Division } B& \text { Division } C\\\text { Sales } & ? & ? & 1,250,000 \\\text { Net operating income } & \$ 40,000 & \$ 25,000 & \$ 75,000 \\\text { Average operating assets } & 400,000 & ? & ? \\\text { Return on inv estment } & ? & 20 \% & 15 \% \\\text { Margin } & 0.10 & 0.05 & ? \\\text { Turnover } & 1.0 & ? & ? \\\text { Target ROI } & 14 \% & 12 \% & 10 \%\end{array}$

-Refer to Zorro Company. What is the residual income for Division A?

A) ($36,000)
B) ($16,000)
C) $36,000
D) $45,000

Question 79

Which performance measure uses after-tax operating income and the actual cost of capital employed?

A) margin
B) residual income
C) return on investment (ROI)
D) economic value added (EVA)

Question 80

Borraw Company
The following information pertains to the three divisions of Borraw Company: $\begin{array}{lll}&\text { Division } A & \text { Division } B\\\text { Sales } & ? & 1,250,000 \\\text { Net operating income } & \$ 25,000 & \$ 75,000 \\\text { Average operating assets } & ? & ? \\\text { Rebum on investment } & 20 \% & 15 \% \\\text { Margin } & 0.05 & ? \\\text { Tumover } & ? & ? \\\text { Target ROI } & 12 \% & 10 \%\end{array}$

-Refer to Borraw Company. What are the sales for Division A?

A) $25,000
B) $125,000
C) $208,333
D) $500,000