Chapter 19 – Divisional financial performance measures
MULTIPLE CHOICE
1. Types of responsibility centres include all of the following EXCEPT
a.
profit centres.
b.
contribution centres.
c.
investment centres.
d.
cost centres.
2. The Marketing Department is most likely considered to be a(n)
a.
profit centre.
b.
revenue centre.
c.
investment centre.
d.
cost centre.
3. The Production Department is most likely considered to be a(n)
a.
profit centre.
b.
contribution centre.
c.
investment centre.
d.
cost centre.
4. Profit centre managers would be evaluated based on
a.
operating income of the profit centre.
b.
return on investment.
c.
economic value added.
d.
all of the above.
5. Investment centre managers would be evaluated based on
a.
operating income of the profit centre.
b.
return on investment.
c.
economic value added.
d.
all of the above.
6. Advantages of decentralization include all of the following EXCEPT
a.
divisional management is able to react to changing market conditions more rapidly than
top management.
b.
divisional management is a source of personnel for promotion to top management
positions.
c.
decentralization can motivate divisional managers.
d.
decentralization permits divisional management to concentrate on firmwide problems and
long-range planning.
7. Decentralization occurs when
a.
the firm’s operations are located over a large geographic area to reduce risk.
b.
authority for important decisions is delegated to lower segments of the organization.
c.
important decisions are made at the upper levels and the lower levels of the organization
are responsible for implementing the decisions.
d.
None of the above are correct.
8. Return on investment can be broken into two components:
a.
profit margin and asset turnover.
b.
contribution margin and asset turnover.
c.
segment margin and asset turnover.
d.
profit margin and inventory turnover.
9. The evaluation of investment centres and the evaluation of the managers who run them
a.
should be the same evaluation.
b.
should be separate evaluations.
c.
should be done quarterly.
d.
None of the above are correct.
10. Return on investment (ROI) is calculated as
a.
Operating income/Average operating assets.
b.
(Operating income/Sales) (Sales/Average operating assets).
c.
Operating income margin Operating asset turnover.
d.
all of the above.
11. Return on investment (ROI) is calculated as
a.
Divisional operating income/Divisional investment.
b.
Divisional investment – Division income.
c.
Divisional investment/Divisional operating income.
d.
Divisional income – (Divisional investment Required rate of return).
12. Assuming all other things are equal, a company’s ROI would decrease when
a.
operating expenses increase.
b.
operating income increases.
c.
average operating assets decrease.
d.
operating expenses decrease.
13. Evaluating performance using ROI encourages managers to focus on
a.
income and investment.
b.
cost efficiency and operating asset efficiency.
c.
both a and b.
d.
neither a nor b.
14. A disadvantage of ROI is
a.
it leads to goal incongruence.
b.
its short-run focus.
c.
its focus on divisional profit rather than overall profit of the firm.
d.
all of the above.
15. What is an advantage of using economic value added (EVA) in performance measurement over return
on investment (ROI)?
a.
It is easier to calculate.
b.
It encourages investments that are profitable to the company.
c.
both a and b
d.
none of the above
16. Economic value added (EVA) is
a.
before-tax operating income minus the total annual cost of capital.
b.
after-tax operating income minus the total annual cost of capital.
c.
after-tax operating income minus the before-tax cost of debt.
d.
none of the above.
17. Economic value added (EVA) is
a.
a monetary figure.
b.
a percentage rate of return.
c.
negative if the company is creating capital.
d.
none of the above.
18. In order to promote goal congruence, a manager of an investment centre is best evaluated using
a.
standard variable costing income statements.
b.
budgets and standard costs.
c.
return on investment.
d.
economic value added.
19. Which of the following measures should companies use for performance evaluation?
a.
ROI
b.
EVA
c.
nonfinancial measures such as market share and customer’s complaints
d.
all of the above
20. A negative EVA means
a.
the company is destroying capital.
b.
the company is increasing capital.
c.
ROI is negative.
d.
both a and c.
21. The following information is provided:
Operating
Average Operating
Project
Income
Investment
A
£44,000
£400,000
B
70,000
800,000
C
30,000
600,000
Assume the division’s current ROI is 10 per cent and the firm’s minimum required rate of return is 8
per cent.
If you were the division manager and you were evaluated based on ROI, which projects would you
accept?
a.
Projects A, B, and C
b.
Projects A and C
c.
Projects A and B
d.
Project A only
22. The following information is provided:
Project
Income
Investment
A
£33,000
£300,000
B
56,250
750,000
C
27,500
550,000
Assume the division’s current ROI is 10 per cent and the firm’s minimum required rate of return is 7
per cent.
If you were the president of the company, which projects would you want the division manager to
accept?
a.
Projects A, B, and C
b.
Projects A and C
c.
Projects A and B
d.
Project A only
PTS: 1 REF: 19.7
Figure 19-1
Project
Income
Investment
A
£40,000
£800,000
B
44,000
400,000
C
46,875
625,000
Assume the division’s current ROI is 10 per cent and the firm’s minimum required rate of return is 6
per cent.
23. Refer to Figure 19-1. If you were the division manager and you were evaluated based on ROI, which
projects would you accept?
a.
Projects A, B, and C
b.
Projects A and B
c.
Projects B and C
d.
Project B only
24. Refer to Figure 19-1 above. If you were the president of the firm, which projects would you want the
division manager to accept?
a.
Projects A, B, and C
b.
Projects B and C
c.
Project A only
d.
Project B only
25. The operating margin for the Randall Company last year was 8 per cent. If total sales are £1,250,000
and average operating assets are £400,000, ROI was
a.
25%.
b.
20%.
c.
16%.
d.
10%.
26. If Dixie Company has sales of £1,200,000 and operating assets of £600,000, what operating margin
will they have to earn to generate an ROI of 20 per cent?
a.
5%
b.
7.5%
c.
10%
d.
20%
27. The sales in the Components Division last year totaled £600,000, and its ROI was 15 per cent. If the
company’s operating margin was 5 per cent, then its average operating assets must have been
a.
£4,000,000.
b.
£200,000.
c.
££60,000.
d.
It cannot be determined from the information given.
28. GreenWorld Company wants to increase its ROI from 20 per cent to 25 per cent in the current year.
They cannot increase operating income and sales from the previous year’s levels of £50,000 and
£1,200,000, respectively. To increase ROI, GreenWorld should
a.
make additional investments of £25,000.
b.
sell obsolete inventory for £10,000 and use the proceeds to pay off debts.
c.
sell obsolete inventory for £50,000 and use the proceeds to pay off debts.
d.
GreenWorld can’t increase ROI.
29. The following information was extracted from the accounting records of Florissant Valley Motors:
Prior Year
Current Year
Margin
6.0
5.0
Turnover
2.5
3.2
Florissant Valley’s ROI for the current year is
a.
greater than for the prior year due to the change in turnover.
b.
greater than for the prior year due to the change in margin.
c.
less than for the prior year due to the change in turnover.
d.
less than for the prior year due to the change in margin.
Figure 19-2
The following results for the year pertain to the Northern Division of Garvey Ltd.:
Sales
£400,000
Taxes
60,000
Operating income after taxes
160,000
30. Refer to Figure 19-2. Northern’s total capital employed is £1,200,000, and their weighted average cost
of capital is 12 per cent. Economic value added for the Northern Division is
a.
£240,000.
b.
£144,000.
c.
(£104,000).
d.
£16,000.
31. Refer to Figure 19-2. If Northern’s average operating assets are £1,200,000 and their minimum
required rate of return is 12 per cent, what is the Northern Division’s return on investment?
a.
33.3%
b.
18.3%
c.
13.3%
d.
12.0%
Figure 19-3
The following results for the year pertain to the Maddox Division of Ryan Ltd.:
Sales
£640,000
Variable expenses
160,000
Fixed expenses
300,000
The weighted average cost of capital is 12 per cent. The firm’s minimum required rate of return is 14
per cent. Taxes for the firm are 40 per cent.
32. Refer to Figure 19-3. If average operating assets are £1,000,000, return on investment for the
Maddox Division is
a.
48%.
b.
34%.
c.
18%.
d.
16%.
33. Refer to Figure 19-3. If the total capital employed by the Maddox Division is £800,000, what is the
economic value added (EVA)?
a.
£12,000
b.
£96,000
c.
£108,000
d.
£180,000
34. Dizzy Company’s Asian Division employed capital of £250,000 last year. If the weighted average cost
of capital is 15 per cent and if last year’s after-tax income was £50,000, then EVA for the Asian
Division last year was
a.
£2,500.
b.
£37,500.
c.
£12,500.
d.
£7,500.
35. The EVA of Credit Financial’s African Division was (£15,000) last year. If after-tax income is £60,000
and the capital employed totaled £500,000, what is the weighted average cost of capital?
a.
15%
b.
3%
c.
12%
d.
9%
36. The manager of an investment centre is responsible for
a.
decisions regarding costs.
b.
decisions regarding revenues.
c.
decisions to invest in assets.
d.
all of the above.
37. The manager of a cost centre is responsible for
a.
decisions regarding costs.
b.
decisions regarding revenues.
c.
decisions to invest in assets.
d.
both a and b.
38. Which of the following departments would NOT be a cost centre?
a.
advertising department
b.
city police department
c.
building and grounds department
d.
sales department
39. An example of an investment centre is a
a.
production department.
b.
company.
c.
marketing department.
d.
credit department.
40. ____ is the delegation of decision-making authority to successively lower management levels in an
organization.
a.
Decentralization
b.
Centralization
c.
Optimization
d.
An unfavorable overhead variance
41. ____ exists when the major functions of organization are controlled by top management.
a.
Decentralization
b.
Centralization
c.
Optimization
d.
An unfavorable overhead variance
42. A possible disadvantage of a decentralized organization is that
a.
decisions are made more slowly.
b.
divisional managers are less motivated.
c.
divisional managers are not specialized.
d.
divisional managers will run their divisions to benefit themselves at the expense of
suboptimizing the entire organization.
43. Which of the following is a disadvantage of both residual income and ROI?
a.
They are both absolute measures of return.
b.
They both are difficult to calculate.
c.
They both do not discourage myopic behaviour.
d.
All of the above are disadvantages of both ROI and residual income.
44. The following information pertains to the three divisions of Marlow Company:
Division X
Division Y
Division Z
Sales
?
?
1,250,000
Net operating income
£36,000
£25,000
£75,000
Average operating assets
300,000
?
?
Return on investment
?
20%
15%
Margin
0.10
0.05
?
Turnover
1.5
?
?
Target ROI
15%
12%
10%
What is the residual income for Division X?
a.
£36,000
b.
£45,000
c.
£(9,000)
d.
£(36,000)
45. Correll Company has two divisions, A and B. Information for each division is as follows:
____A____
____B____
Net earnings for division
£40,000
£260,000
Asset base for division
£100,000
£1,200,000
Target rate of return
15%
18%
Margin
10%
20%
Weighted average cost of capital
12%
12%
What is the residual income for A?
a.
£40,000
b.
£25,000
c.
£15,000
d.
£28,000
Figure 19-4
Beta Division had the following information:
Asset base in Beta Division
£400,000
Net income in Beta Division
£50,000
Weighted average cost of capital
12%
Target ROI
15%
Margin for Beta Division
20%
46. Refer to Figure 19-4. What is the residual income for Beta Division?
a.
£60,000
b.
£48,000
c.
£7,500
d.
£(10,000)
47. Refer to Figure 19-4. What is EVA for Beta Division?
a.
£60,000
b.
£48,000
c.
£7,500
d.
£2,000
SHORT ANSWER
1. Compare and contrast decentralization and centralization.
2. a. Identify advantages of a decentralized approach to management.
b. In comparison, identify advantages of a centralized approach to management.
3. Explain why an organization should not use only financial measures to monitor performance.
PROBLEM
1. The following results for the current year are for the Grundy Division of Salmon Enterprises:
Sales
£700,000
Variable costs
_260,000
Contribution margin
£440,000
Fixed expenses
_300,000
Divisional income
£140,000
Average operating assets are £1,400,000. The firm’s minimum required rate of return is 8 per cent.
The weighted average cost of capital is 6 per cent. The division’s tax rate is 30 per cent.
Required:
a.
Calculate profit margin for the division.
b.
Calculate asset turnover for the division.
c.
Calculate return on investment (ROI) for the division.
d.
Calculate economic value added (EVA) for the division.
2. The manager of the recently formed Oak Division of Parkes, Incorporated, is evaluating the following
four investment opportunities available to the division. Parkes, Incorporated, requires a minimum
return of 10 per cent.
Investment
Opportunity
Income
Investment
1
£ 91,000
£650,000
2
63,000
700,000
3
59,400
540,000
4
117,600
980,000
Required:
a.
Calculate the return on investment (ROI) for each investment opportunity.
b.
If only one investment opportunity can be funded and the division is evaluated based on ROI,
which investment opportunity would be accepted?
c.
If Parkes, Incorporated, can fund all of the projects and wishes to achieve the best possible
performance, which investments would be accepted?
a.
Project 1: 14% £91,000/£650,000
Project 2: 9% £63,000/£700,000
Project 3: 11% £59,400/£540,000
Project 4: 12% £117,600/£980,000
b.
Project 1, because it has the highest ROI
a.
20% £140,000/£700,000
b.
50% £700,000/£1,400,000
c.
10% £140,000/£1,400,000
£14,000 [£140,000 (1 – .3)] – (£1,400,000 6%)
3. TotToys Ltd. recently made £2,000,000 of capital available to its Toddler Division. The manager of
the Toddler Division is evaluating the possibility of investing the additional funds in two new toys.
Information about the two new toys is as follows:
Toy #1
Toy #2
Projected investment
£900,000
£750,000
Expected operating income
144,000
90,000
Any funds not invested in a project will be invested to earn the company’s required minimum return of
10 per cent. Without the additional investment, the Toddler Division’s average operating assets would
have been £10,000,000, and its operating income would have been £1,400,000.
Required:
a.
Compute the Toddler Division’s operating income and ROI, assuming that the division
manager rejects both projects.
b.
Compute the Toddler Division’s operating income and ROI, assuming that the division
manager accepts only the Toy #1 project.
c.
Compute the Toddler Division’s operating income and ROI, assuming that the division
manager accepts only the Toy #2 project.
d.
Compute the Toddler Division’s operating income and ROI, assuming that the division
manager accepts both projects.
£1,600,000 £1,400,000 + (£2,000,000 10%)
13.33% £1,600,000/(£10,000,000 + £2,000,000)
£1,654,000 £1,400,000 + £144,000 + [(£2,000,000 – £900,000) 10%]
13.78% £1,654,000/(£10,000,000 + £2,000,000)
£1,615,000 £1,400,000 + £90,000 + [(£2,000,000 – £750,000) 10%]
13.46% £1,615,000/(£10,000,000 + £2,000,000)
d.
£1,669,000 £1,400,000 + £144,000 + £90,000 +
[(£2,000,000 – £900,000 – £750,000) 10%]
13.91% £1,669,000/(£10,000,000 + £2,000,000)
(Round all computations to the nearest two decimal places.)
4. The following results for the current year are for the Calvin Division of Stinson Enterprises:
Sales
£400,000
Variable costs
180,000
Contribution margin
£220,000
Fixed expenses
160,000
Divisional income
£ 60,000
Projects 1, 3, and 4; their ROIs exceed the minimum return of 10 per cent.
Average operating assets are £500,000. The firm’s minimum required rate of return is 10 per cent, the
weighted average cost of capital is 8 per cent, and the tax rate is 30 per cent.
Required:
a.
Calculate profit margin for the division.
b.
Calculate asset turnover for the division.
c.
Calculate return on investment (ROI) for the division.
d.
Calculate economic value added (EVA) for the division.
5. Mr. Baker, a divisional manager, is compensated as follows:
•
An annual salary of £85,000
•
A bonus of 1 per cent of divisional income
•
Stock options for 6,000 shares of company stock (The options permit Mr. Baker to
purchase the stock at £45 per share.)
Mr. Baker’s division reported operating income of £5,000,000 this year. On December 1, Mr. Baker
exercised his stock option when the stock was selling for £57 per share.
Required:
a.
Determine the amount of Mr. Baker’s bonus for the year.
b.
Determine the value of the stock option to Mr. Baker.
c.
Determine the total amount of Mr. Baker’s compensation for the year.
£50,000 £5,000,000 1%
b.
£72,000 (£57 – £45) 6,000
c.
£207,000 £85,000 + £50,000 + £72,000
6. Discuss the differences between centralized and decentralized decision making. Why would a firm
decentralize its operations?
15% £60,000/£400,000
b.
80% £400,000/£500,000
12% £60,000/£500,000
d.
£2,000 [£60,000 (1 – .3)] – (£500,000 8%)
7. O’Neil Company requires a return on capital of 15 per cent. The following information is available for
2011:
Division X
Division Y
Division Z
Book
Current
Book
Current
Book
Current
Sales
£200,000
£200,000
£400,000
£400,000
£600,000
£600,000
Income
24,000
20,000
32,000
34,000
37,500
39,000
Assets
120,000
160,000
180,000
200,000
450,000
435,000
Required:
a.
Compute return on investment using both book and current values for each division. (Round
answer to three decimal places.)
b.
Compute residual income for both book and current values for each division.
c.
Does book value or current value provide the better basis for performance evaluation?
d.
Which division do you consider the most successful?
Current
Book
Current
b.
Unfortunately, they are more costly to acquire than book values.
values.
8. Stevens Company has two divisions that report on a decentralized basis. Their results for 2011 were as
follows:
Helmet
Ball
Sales
£150,000
£300,000
Income
£ 15,000
£ 45,000
Asset base
£ 75,000
£150,000
Weighted average cost of capital
12%
12%
Required:
Compute the following amounts for each division:
a.
Return on investment (ROI) if the desired rate of return is 12 per cent.
b.
Residual income if the desired rate of return is 20 per cent.
c.
EVA.
d.
Turnover if the desired rate of return is 25 per cent.
e.
Margin for each division if the desired rate of return is 10 per cent.
ESSAY
1. Compare and contrast return on investment (ROI) and economic value added (EVA).
2. Why do firms decentralize?