Question 1

Net book value produces a misleading increase in return on investment because:

Accepted Answer

Net book value is calculated by deducting accumulated depreciation from the original cost of an asset. As an asset ages, its net book value decreases, leading to a higher return on investment for the investment centre because the denominator (net book value) is decreasing. However, this can be misleading because the investment centre with older assets may not be generating actual higher returns compared to a centre with newer assets.

Question 2

The advantage of residual income as a measure of investment centre performance is:

Accepted Answer

Residual income includes the organization's minimum required rate of return, which helps in assessing whether an investment center is generating returns above the minimum threshold.

Question 3

The return on investment can be defined as:

Accepted Answer

Return on investment is calculated by dividing the profit by the capital invested. It shows the amount of profit earned per dollar of capital invested. Therefore, option C is the correct answer as it correctly defines the return on investment.

Question 4

Which of the following is an example of an intrinsic reward?

Accepted Answer

Personal satisfaction is an example of an intrinsic reward. It is an internal feeling of accomplishment or fulfillment that comes from within the individual. The other options - cash bonus, larger office, and certificate of merit - are all extrinsic rewards, which are external rewards given by someone else.

Question 5

Calculate the return on investment of new equipment in the first year if:
Profit = $3 000 000
Invested capital = $45 000 000
Increase in divisional profits = $45 000
Purchase of new machine = $900 000

Accepted Answer

The answer of Calculate the return on investment of new...

Question 6

For Mildura Ltd, if the sales are $1 500 000, the invested capital $450 000 and the profit $90 000, what is the asset turnover for the year?

Accepted Answer

Asset turnover is calculated as Sales divided by Invested Capital. Here, $1,500,000 / $450,000 = 3.33, which is 333% when expressed as a percentage.

Question 7

The asset turnover of an organisation can be calculated as:

Accepted Answer

Asset turnover is a financial ratio that measures how efficiently a company is using its assets to generate revenue. It is calculated by dividing sales revenue by total invested capital. This shows how much revenue is generated for each unit of investment in the company's assets. Therefore, option A is the correct answer.

Question 8

The following information pertains to Bingo Concrete for the year 2008:
Sales are $1 500 000
Gross margin is $600 000
Profit is $90 000
What is the profit margin for the year?

Accepted Answer

The profit margin is calculated as (Profit / Sales) * 100. So, for Bingo Concrete, it's ($90,000 / $1,500,000) * 100 = 6%.

Question 9

For Echuca Ltd sales are $1 500 000, profit is $90 000, invested capital is $450 000 and the interest rate is 8 per cent. What is the residual income for the year?

Accepted Answer

The answer of For Echuca Ltd sales are $1 500...

Question 10

Calculate the asset turnover from the following data:

Accepted Answer

The answer of Calculate the asset turnover from the following...

Question 11

Fine Furnishings Pty Ltd earned residual income of $40 000 during the year. The net profit was $160 000 during the year and the cost of capital was 12 per cent. What was the return on investment for the year?

Accepted Answer

Residual income is calculated as Net Profit - (Investment * Cost of Capital). Given that the residual income is $40,000 and the net profit is $160,000, we can set up the equation $160,000 - (Investment * 12%) = $40,000. Solving for Investment gives us $1,000,000. Therefore, the return on investment (ROI) is Net Profit / Investment = $160,000 / $1,000,000 = 16%.

Question 12

Which of the following statements is false?

Accepted Answer

Pay systems may focus on both short-term and long-term results depending on the company's goals and strategies. Some pay systems may focus primarily on short-term goals such as meeting sales targets, while others may focus on long-term goals such as increasing market share or developing new products.

Question 13

One of the disadvantages of return on investment is that:

Accepted Answer

Return on Investment (ROI) can discourage managers from investing in profitable projects if those projects do not meet a certain ROI threshold, potentially leading to underinvestment in projects that could benefit the company in the long term.

Question 14

Holt Company Ltd determined residual income for the year of $22 000. The company's cost of capital was 12 per cent, the investment turnover was 2.0, and capital invested was $400 000. What was Holt Company's profit during the year?

Accepted Answer

Residual income is calculated as profit minus the product of capital invested and cost of capital. Given residual income is $22,000, cost of capital is 12%, and capital invested is $400,000, the profit can be calculated as follows: Profit = Residual Income + (Capital Invested * Cost of Capital) = $22,000 + ($400,000 * 0.12) = $70,000.

Question 15

Which of the following gives a more accurate calculation of return on investment and residual income?

Accepted Answer

Average invested capital is a better choice as it takes into account the fluctuation in capital investment over time. It is calculated by averaging the beginning and ending capital investment. Total assets (B) can skew the return calculation as it includes non-operating assets, and total capital invested (A) does not account for changes in investment over time. Average cost of capital (D) is not a measure of return on investment or residual income, but rather the cost of financing the investment.

Question 16

Joy Home Fashions reported a return on investment during the year of 6 per cent and a profit margin of 12 per cent. What was the investment turnover for the year?

Accepted Answer

To find the investment turnover, we need to use the formula:
Return on Investment = Profit Margin x Investment Turnover
6% = 12% x Investment Turnover
Investment Turnover = 6%/12% = 0.5 = 50%. Therefore, the answer is B.

Question 17

Precious Metals Pty Ltd earned residual income of $70 000 during the year. The net profit was $250 000 during the year and the required return was 15 per cent. What was the invested capital?

Accepted Answer

Residual income is calculated as Net Profit - (Invested Capital * Required Return). Given that Residual Income = $70,000, Net Profit = $250,000, and Required Return = 15%, we can set up the equation $70,000 = $250,000 - (Invested Capital * 15%). Solving for Invested Capital gives us $1,200,000.

Question 18

Bricker Fabrics reported a profit margin during the year of 20 per cent and an investment turnover of 40 per cent. What was its return on investment for the year?

Accepted Answer

Return on investment = profit margin x investment turnover 
Return on investment = 20% x 40% = 8%

Question 19

Managers' performance in an investment centre can best be evaluated by:

Accepted Answer

Evaluating a manager's performance in an investment centre should be based on those revenues, costs, and investments that they can control, which is the most accurate reflection of their performance. Choices A, B, and C are not comprehensive enough or may include factors outside of the manager's control.

Question 20

One of the advantages of using net book value to measure invested capital is that:

Accepted Answer

Using net book value to measure invested capital maintains consistency with the balance sheet prepared for external reporting purposes. This is important for ensuring accurate and transparent financial information for shareholders, investors, and other stakeholders. However, net book value may not allow for easy comparison of return on investment with different companies, as it reflects historical cost rather than market value.

Quiz 13: Financial Performance Measures and Incentive Schemes