Question 1

Alice and Jon Harrison operate two full-service dry cleaning outlets in the St. Louis metropolitan area. One of the outlets generates over $800,000 revenue per year and has more than a million dollar investment in state-of-the-art equipment. The other outlet is older, generates $20,000 revenue per month, and has 20-25 year-old equipment currently worth approximately $85,000. Both outlets are profitable with growing market bases. (The ratio between operating income and sales for each unit, based on historical-cost accounting numbers, is roughly the same.) Managers at each location are currently paid a base salary, and receive a year-end bonus which is five percent of total operating profit produced by both outlets combined. Alice has just finished a workshop on investment center performance evaluation, and wants to change the evaluation and reward structure, hoping to motivate the two managers to produce greater revenue and profit.
Required:
What type of evaluation mechanisms should she propose for the two managers?

Accepted Answer

The answer of Alice and Jon Harrison operate two full-service...

Question 2

Managerial performance can be measured in various ways, including return on investment (ROI) and residual income (RI). A good reason for using RI rather than ROI is:

Accepted Answer

RI promotes goal congruence because it measures the actual dollar amount of economic value added above a minimum required return, rather than just the percentage return on investment. This encourages managers to make decisions that increase the overall profitability of the company, rather than just focusing on maximizing the return on their specific investment.

Question 3

Which of the following is a true about return on investment (ROI)?

Accepted Answer

B) Its use can motivate suboptimal decision making on the part of subunit managers. This is because managers might focus on decisions that improve ROI in the short term at the expense of the company's long-term health.

Question 4

Return on investment (ROI), residual income (RI), and Economic Value Added (EVA) all have in common which one of the following characteristics?

Accepted Answer

ROI, RI, and EVA all incorporate a measure of investment in their performance metrics. ROI is calculated by dividing the income from an investment by the investment amount, RI calculates income earned above a specified minimum return on investment, and EVA calculates economic profit after taking into account the cost of capital. Therefore, option E is the correct choice. The other options are not entirely correct as they do not apply to all three metrics mentioned.

Question 5

Decentralized firms can delegate authority and yet retain control and monitor managers' performances by structuring the organization into so-called "responsibility centers." Which one of the following business segments/responsibility centers is most like an independent business?

Accepted Answer

Investment centers are treated most like independent businesses because they are responsible not only for generating profits but also for managing their investments and assets. This gives managers control over decisions that affect both the revenue and the cost side of their operations, closely mimicking the responsibilities of an independent business owner.

Question 6

Assume that the Entertainment Division is able to purchase a large quantity of video cards from an outside source at $8.70/unit. The Video Cards Division, having excess capacity, agrees to lower its transfer price to $8.70/unit. This action would likely:

Accepted Answer

The answer of Assume that the Entertainment Division is able...

Question 7

Selected data from an investment center's accounting records reveal the following:
  Required:
1. Calculate return on investment (ROI) for this investment center (show separately the two major components of the ROI calculation)
2. Calculate residual income (RI) for this investment center.
Round all computations to two decimal places.

Accepted Answer

The answer of Selected data from an investment center's accounting...

Question 8

Economic value added (EVA) for a division:

Accepted Answer

Economic value added (EVA) is a financial performance measure that calculates the amount by which the division's actual earnings (adjusted for bias effects of accounting conservatism) exceed the company's cost of capital. The positive EVA indicates that the division has created value for the company by generating earnings in excess of the cost of capital. Therefore, choice C is the correct option. The other options are incorrect because they do not accurately reflect the nature of EVA.

Question 9

Consider the following data for three divisions of a company, X, Y, and Z:
  Required:
Calculate return on investment (ROI), return on sales (ROS), and asset turnover (AT) for each division. Round your answers to two decimal places where appropriate.

Accepted Answer

The answer of Consider the following data for three divisions...

Question 10

The Plastics Division sells its commercial products at full cost plus a 25% markup and believes the proprietary plastic component made for the Entertainment Division would sell for $6.25/unit on the open market. The market price of the video card used by the Entertainment Division is $10.98/unit. A per-unit transfer price from the Video Cards Division to the Entertainment Division at full cost, $9.15, would:

Accepted Answer

The answer of The Plastics Division sells its commercial products...

Question 11

Which of the following is not a criticism of using return on investment (ROI) for divisional performance evaluation?

Accepted Answer

All of the other choices are criticisms of using ROI for divisional performance evaluation. Choice B, on the other hand, is a potential criticism of the way ROI is calculated, but it is not a criticism of using the metric itself for performance evaluation. In fact, ROI is specifically designed to take capital invested into account, so it can be argued that this is actually a strength of the metric rather than a weakness.

Question 12

Assume that the Plastics Division has excess capacity and it has negotiated a transfer price of $5.60 per plastic component with the Entertainment Division. This price will likely:

Accepted Answer

The answer of Assume that the Plastics Division has excess...

Question 13

James Webb is the general manager of the Industrial Product Division, and his performance is measured using the residual income (RI) method. Webb is reviewing the followed forecasted information for his division for the coming year:  If the imputed interest charge is 15% and Webb wants to achieve an RI target of $2 million, what will costs have to be in order to achieve the target?

Accepted Answer

To calculate the required costs to achieve the target RI, we need to use the following formula:

RI = Operating Income - (Imputed Interest Rate x Total Assets)

We are given that the target RI is $2 million and the imputed interest charge is 15%. Total assets are provided in the table as $167 million, so we can solve for operating income:

$2,000,000 = Operating Income - (0.15 x $167,000,000)
$2,000,000 = Operating Income - $25,050,000
Operating Income = $2,000,000 + $25,050,000
Operating Income = $27,050,000

Now we can use the formula for operating income:

Operating Income = Sales - Variable Costs - Fixed Costs

Plugging in the values from the table, we get:

$27,050,000 = $56,000,000 - $30,350,000 - Fixed Costs

Solving for fixed costs:

Fixed Costs = $56,000,000 - $30,350,000 - $27,050,000
Fixed Costs = $25,150,000

Therefore, the costs will have to be $25,150,000 in order to achieve the target RI of $2 million. The correct answer is D) $25,150,000.

Question 14

Which one of the following statements pertaining to the return on investment (ROI) as a divisional performance measure is incorrect?

Accepted Answer

While ROI does rely on financial measures that can be independently verified, it is not necessarily true that other forms of performance measures are subject to manipulation. Additionally, it is important to note that ROI should not be the only criteria for making investment decisions and that other methods such as DCF models should also be considered. The other statements regarding ROI are generally accurate.

Question 15

Residual income (RI) may be a better measure for performance evaluation of an investment center manager than return on investment (ROI) because:

Accepted Answer

Residual income encourages managers to make profitable investments that may have a lower return on investment (ROI) but still add to the overall profitability of the company. This avoids the issue where managers of high-return divisions might reject projects that, while profitable, could lower their division's overall ROI.

Question 16

Ellie Jackson is upset by the new transfer pricing system recently implemented at Monson Company. As manager of the first of three sequential production departments, she can't see the value of a transfer pricing system for her department. "We can't sell what we produce to any outside buyer. And we're never pushed for capacity, so I don't think transfer pricing will do anything but make my life more complicated." You are Ellie's boss.
Required:
Explain how transfer pricing can help Ellie evaluate her department's operations and allow you to more effectively evaluate her management abilities.

Accepted Answer

The answer of Ellie Jackson is upset by the new...

Question 17

The basic objective of the residual income (RI) approach to divisional performance measurement and evaluation is to have a division maximize its

Accepted Answer

The residual income (RI) approach focuses on ensuring a division generates operating income that exceeds a charge for the capital invested in the division. This approach encourages divisions to make investments that yield returns above the minimum required rate of return, thus maximizing wealth for the entire company.

Question 18

Which of the following items would most likely not be incorporated into the calculation of a division's investment base when using the residual income (RI) approach for performance measurement and evaluation?

Accepted Answer

Land being held for future use is not typically considered part of the division's investment base because it is not actively being used to generate revenue or profits for the division. The other items listed (fixed assets, inventory, accounts payable, and accounts receivable) are all typically included in the calculation of a division's investment base when using the RI approach.

Question 19

An appropriate transfer price between two divisions of The Stark Company can be determined from the following data:  What is the natural bargaining range for the two divisions?

Accepted Answer

The answer of An appropriate transfer price between two divisions...

Question 20

Listed below is selected financial information for the Western Division of the Henzel Company for last year:  If Henzel treats the Western Division as an investment center for performance evaluation purposes, what is the before-tax return on investment (ROI) for last year? (Round your answer to two decimal places.)

Accepted Answer

The answer of Listed below is selected financial information for...

Quiz 19: Strategic Performance Measurement: Investment Centers and Transfer Pricing

Managerial performance can be measured in various ways, including return on investment (ROI) and residual income (RI) . A good reason for using RI rather than ROI is:

Which of the following is a true about return on investment (ROI) ?

Return on investment (ROI) , residual income (RI) , and Economic Value Added (EVA) all have in common which one of the following characteristics?