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142. This question deals with summary financial performance indicators for investment
centers.
Required:
1. Discuss the similarities between ROI, residual income (RI), and EVA®.
2. In what sense is EVA® similar to and in what sense is it distinct from residual income (RI)?
3. Present the equation for calculating EVA® and provide a brief discussion of the elements that
go into the calculation of EVA®.
4. What are the two approaches that can be used to estimate the two major components of
EVA®? Which of these two approaches is superior?
143. A fellow student of yours who has just completed a course in management accounting
recently made the following comment to you regarding the establishment of transfer prices for
transnational transfers of goods and services within the same company: "In the process of
preparing consolidated financial statements, all profit and loss attributable to internal transfers
of goods and services are removed. The amount of profit a company reports is therefore affected
only by transactions with external parties. Therefore, the subject of transfer pricing may be
important for motivational purposes or some other managerial objective, but the choice of a
transfer pricing system has no effect on the bottom line, even when transfers are made between
units of a company operating in different countries."
Required:
Critically analyze and respond to the above assertion.
144. Michael Cianci, manager of Division C of the FX Corporation, is considering a new
investment for his division. The division currently has an investment base (i.e., assets) of
$4,000,000, and operating income of approximately $600,000 per year. The new investment of
$500,000 supports corporate strategy and is expected to increase operating income by $50,000
next year, an acceptable level of return from the standpoint of the corporation as a whole.
Required:
1. What is the current return on investment (ROI) for Division C?
2. What will be the ROI of the division if the new investment is undertaken?
3. Suppose the manager's compensation consists of a salary plus a bonus proportional to
divisional ROI. Would the manager's compensation be higher with, or without, the new
investment?
4. Suggest changes to corporate management that will better align performance evaluation and
compensation with corporate goals.
145. This question pertains to the use of market-based transfer prices.
Required:
What is the primary advantage and what is the primary difficulty in using market-based transfer
prices?
146. Pacific Mill consists of two operating divisions, a Cutting division and the Assembly
division. The Cutting division prepares cords of timber at its sawmills, while the Assembly
division prepares the cut cords of lumber into board-feet of finished wood (which is sold to
various furniture manufacturers). During the most recent year the Cutting division prepared
60,000 cords of wood at a cost of $1,320,000. All of this lumber was transferred to the Assembly
division, where incremental costs of $12 per cord were added. Pacific Mill sold the 600,000
board-feet of finished wood for $5,000,000.
Required:
1. What would the operating income for each of the two divisions be if the transfer price from
Cutting to Assembly was set at the cord cost of $22 per cord? (Show calculations.)
2. What would the operating income for each of the two divisions be if the transfer price is set at
$18 per cord? (Show calculations.)
3. Since Cutting transfers all of its output internally (to Assembly), does the manager of Cutting
care what price is selected? Why? Should Cutting be treated as a cost center under the
circumstances (rather than a profit center or investment center)? Explain.
1.
