Chapter 13 – Investment Centers and Transfer Pricing
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Chapter 13
Investment Centers and Transfer Pricing
Answer Key
True / False Questions
1. The biggest challenge in making a decentralized organization function effectively is to
obtain goal congruence among the organization’s autonomous managers.
2. As an organization grows, however, its managers need less formal information systems,
including managerial accounting information, in order to maintain control.
3. Economic value added uses a firm’s weighted-average cost of capital.
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4. Income divided by sales revenue is called capital turnover.
5. A division’s return on investment may be improved by increasing sales margin and cost of
capital.
6. Improving ROI is a balancing act that requires all the skills of an effective manager.
7. One benefit of residual income is that it can be used to compare the performance of
different-sized investment centers.
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8. Residual income facilitates goal congruence while ROI does not.
9. The income calculation for a division manager’s ROI should be based on profit margin
traceable to the division.
10. ROI, residual income, and EVA are computed for a period of time.
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11. ROI is one performance measure that can motivate a manager to make decisions about
costs he or she cannot control.
12. The maximization of profits of the buying division is one of the goals that should be
pursued when setting transfer prices.
13. If the transfer price is set at the market price, the producing division should have the
option of either producing goods for internal transfer or selling in the external market.
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14. The external market price transfer-pricing method can lead to dysfunctional decision-
making behavior by managers.
15. Since most people exhibit risk aversion, managers must be compensated for the risk they
must bear.
16. Investment center performance measures and transfer prices are two internal controls that
prevent dysfunctional decisions by mid-level managers.
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Multiple Choice Questions
17. The biggest challenge in making a decentralized organization function effectively is:
A. earning maximum profits through fair practices.
B. minimizing losses.
18. What practice best describes when divisional managers throughout an organization work
together to achieve the organization’s goals?
A. Participatory management.
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19. Consider the following statements about goal congruence:
I. Goal congruence is obtained when managers of subunits throughout an organization strive
to achieve the goals set by top management.
II. Managers are often more concerned about the performance of their own subunits rather
than the performance of the entire organization.
III. Achieving goal congruence in most organizations is relatively straightforward and easy to
accomplish.
Which of the above statements is (are) true?
A. I only.
20. Which of the following performance measures is (are) used to evaluate the general
financial success or failure of investment centers?
A. Residual income.
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21. ROI is most appropriately used to evaluate the performance of:
A. cost center managers.
22. Which of the following is not considered in the calculation of divisional ROI?
A. Divisional income.
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23. Which of the following is the correct mathematical expression for return on investment?
A. Sales margin capital turnover.
24. The ROI calculation will indicate:
A. the percentage of each sales dollar that is invested in assets.
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25. A company’s sales margin:
A. must, by definition, be greater than the firm’s net sales.
26. Which of the following is the correct mathematical expression to derive a company’s
capital turnover?
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27. Capital turnover shows:
28. Sales margin shows:
A. the amount of income generated by each dollar of capital investment.
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29. Jamison Company had sales revenue and operating expenses of $5,000,000 and
$4,200,000, respectively, for the year just ended. If invested capital amounted to $6,000,000,
the firm’s ROI was:
30. Tempest Enterprises had a sales margin of 5%, sales of $4,000,000, and invested capital
of $5,000,000. The company’s ROI was:
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31. Vello, Inc. reported a return on investment of 12%, a capital turnover of 5, and income of
$180,000. On the basis of this information, the company’s invested capital was:
32. The information that follows relates to Khan Corporation:
Sales margin: 7.5%
Capital turnover: 2
Invested capital: $20,000,000
On the basis of this information, the company’s sales revenue is:
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33. A division’s return on investment may be improved by increasing:
34. All of the following actions are likely to increase ROI except:
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35. Which of the following is used in the calculation of both return on investment and residual
income?
36. Consider the following statements about residual income:
I. Residual income incorporates a firm’s cost of acquiring investment capital.
II. Residual income is a percentage measure, not a dollar measure.
III. If used correctly, residual income may result in division managers making decisions that
are in their own best interest and not in the best interest of the entire firm.
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37. The basic idea behind residual income is to have a division maximize its:
38. Beach Corporation has a return on investment of 15%. A Beach division, which currently
has a 13% ROI and $750,000 of residual income, is contemplating a massive new investment
that will (1) reduce divisional ROI and (2) produce $120,000 of residual income. If Beach
strives for goal congruence, the investment:
A. should not be acquired because it reduces divisional ROI.
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39. The Holder Division of Extraordinary Enterprises has a negative residual income of
$540,000. Holder’s management is contemplating an investment opportunity that will reduce
this negative amount to $400,000. The investment:
40. The Markham Division of World Corporation, which has income of $250,000 and an asset
investment of $1,562,500, is studying an investment opportunity that will cost $450,000 and
yield a profit of $67,500. Assuming that World uses an imputed interest charge of 14%,
would the investment be attractive to:
1—Divisional management if ROI is used to evaluate divisional performance?
2—Divisional management if residual income (RI) is used to evaluate divisional
performance?
3—The management of World Corporation?
Attractive to Markham: ROI
Attractive to Markham: RI
Attractive to World Corp.
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41. The Nashville Division of Country Classics currently reports a profit of $3.6 million.
Divisional invested capital totals $9.5 million; the imputed interest rate is 12%. On the basis
of this information, Nashville’s residual income is:
A. $432,000.
42. The following information relates to the Corner Division of Hometown Enterprises:
Income for the period just ended: $1,500,000
Invested capital: $12,000,000
If the company has an imputed interest rate of 11%, Corner’s residual income would be:
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43. Concert Division reported a residual income of $200,000 for the year just ended. The
division had $8,000,000 of invested capital and $1,000,000 of income. On the basis of this
information, the imputed interest rate was:
44. Foxmoor Corporation uses an imputed interest rate of 13% in the calculation of residual
income. Division X, which is part of Foxmoor, had invested capital of $1,200,000 and an ROI
of 16%. On the basis of this information, X’s residual income was:
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45. Imputed interest can best be described as:
Use the following information to answer questions 47-50.
The following information pertains to Travis Concrete:
Sales revenue $1,500,000
Gross margin 600,000
Income 90,000
Invested capital 450,000
The company’s imputed interest rate is 8%.
46. The capital turnover is: