50) Return on investment is an accounting measure of income minus a dollar amount for required return
on an accounting measure of investment.
51) All other things held constant, increase in assets such as receivables or decrease in operating income
results in an increase in return on investment.
52) The DuPont method recognizes the two basic ingredients in profit making: increasing the income per
dollar of revenues and using assets to generate more revenues.
53) To evaluate overall aggregate performance, return on investment and residual income measures are
more appropriate than return on sales.
54) Required rate of return multiplied by the investment is the weighted average cost of the investment.
55) Historical costs are costs recognized in particular situations that are not usually recognized by accrual
accounting procedures.
56) The objective of maximizing return on investment may induce managers of highly profitable divisions
to reject projects that from the viewpoint of the overall organization should be accepted.
57) Return on investment, Residual income, or Economic value added measures are more appropriate
than return on sales because they consider only the investment to measure the performance.
58) Economic value added, unlike residual income, charges managers for the costs of their investments in
long-term assets and working capital.
59) Companies that adopt the EVA concept define investment as total assets employed minus current
liabilities.
60) In an EVA calculation, the corporate charge for a division’s investment is based on a weighted
average of the after-tax interest rate on the firm’s debt and the cost of the firm’s equity.
61) In an EVA calculation, the measure of the invested capital for a division would be that division’s
assets minus that division’s long-term liabilities.
23
62) In an EVA calculation, the appropriate measure of a division’s profit would be that division’s pre-tax
operating income.
63) Antique Corp uses the investment center concept for the museums that it manages. Selected operating
data for three of its museums for 2015 are as follows:
Ohio
Dallas
Texas
Revenue
$1,200,000
$1,500,000
$1,800,000
Operating assets
700,000
500,000
600,000
Net operating income
105,000
115,000
120,000
Required:
a. Compute the return on investment for each division.
b. Which museum manager is doing best based only on ROI? Why?
c. What other factors should be included when evaluating the managers?
64) Gas Supply Corporation uses the investment center concept for the gasoline stations that it manages
in the city. Consolidated has a 15% required rate of return on investment in order for a branch station to
be viable. Select operating data for three of its stations for 2015 are as follows:
Maple Street
Oak Street
High Street
Revenue
$17,000,000
$13,500,000
$15,000,000
Operating assets
7,000,000
7,000,000
6,000,000
Net operating income
900,000
1,200,000
980,000
Required:
a. Compute the return on investment for each station.
b. Which station manager is doing best based only on ROI? Why?
c. Are any of the stations in danger of being closed due to lack of performance?
d. What other factors should be included when evaluating the managers?
65) Moto Corp allows its divisions to operate as autonomous units. The operating data for 2015 follow:
Plows
Tractors
Combines
Revenues
$2,250,000
$500,000
$4,800,000
Accounts receivable
800,000
152,500
1,435,000
Operating assets
1,000,000
400,000
1,750,000
Net operating income
220,000
60,000
480,000
Taxable income
165,000
90,000
385,000
Required:
a. Compute the investment turnover for each division.
b. Compute the return on sales for each division.
c. Compute the return on investment for each division.
d. Which division manager is doing best? Why?
e. What other factors should be included when evaluating the managers?
For parts (b) and (c) income is defined as operating income.
66) Provide the missing data for the following situations:
Red Division
White Division
Blue Division
Sales
$?
$10,000,000
$?
Net operating income
$200,000
$400,000
$288,000
Operating assets
$?
$?
$1,600,000
Return on investment
0.16
0.10
?
Return on sales
0.04
?
0.12
Investment turnover
?
?
1.5
67) Craylon Corp has three divisions, which operate autonomously. Their results for 2015 were as
follows:
East
West
International
Sales
$30,000,000
$40,000,000
$50,000,000
Cost of goods sold
15,000,000
25,000,000
37,000,000
Operating income
4,500,000
5,000,000
5,500,000
Investment base
30,000,000
32,000,000
34,000,000
The company’s desired rate of return is 15%.
Required:
a. Compute each division’s ROI. Round to three decimal places.
b. Compute each division’s residual income.
East
West
International
Investment base
Minimum rate
Minimum return
Operating Income
$4,500,000
$5,000,000
$5,500,000
Minimum return
4,500,000
4,800,000
5,100,000
Residual income
$ 200,000
$ 400,000
68) Batman Abstract Company has three divisions that operate autonomously. Their results for 2015 are
as follows:
Riddler
Joker
Penguin
Sales
$5,000,000
$7,000,000
$10,000,000
Contribution margin
1,440,000
1,700,000
3,500,000
Operating income
1,000,000
1,750,000
2,520,000
Investment base
9,000,000
10,000,000
14,000,000
The company’s desired rate of return is 20%.
Required:
a. Compute each division’s ROI.
b. Compute each division’s residual income.
c. Rank each division by both ROI and residual income.
d. Which division had the best performance in 2015? Why?
Riddler
Joker
Penguin
Investment base
$9,000,000
Minimum rate
$1,800,000
$2,000,000
$2,800,000
Income
$1,000,000
$1,750,000
$2,520,000
Minimum return
1,800,000
2,000,000
2,800,000
69) Coptermagic Company supplies helicopters to corporate clients. Coptermagic has two sources of
funds: long term debt with a market and book value of $32 million issued at an interest rate of 10%, and
equity capital that has a market value of $18 million (book value of $8 million). The cost of equity capital
for Coptermagic is 15%, and its tax rate is 30%. Coptermagic has profit centers in four divisions that
operate autonomously. The company’s results for 2015 are as follows:
Operating
Income
Assets
Current
Liabilities
New York
$1,750,000
$11,500,000
$2,500,000
Chicago
2,400,000
9,000,000
3,500,000
Dallas
4,675,000
27,500,000
9,500,000
Los Angeles
4,200,000
25,000,000
8,000,000
Required:
a. Compute Coptermagic’s weighted average cost of capital.
b. Compute each division’s Economic Value Added.
c. Rank the divisions by EVA.
70) Bob’s Cellular Phone Company uses ROI to measure divisional performance. Annual ROI calculations
for each division have traditionally employed the ending amount of invested capital along with annual
operating income and net revenue. The Dupont method is generally used. The company’s Phone
Accessories Division had the following results for the last two years:
2015 ROI = ($2,000,000/$20,000,000) × ($20,000,000/$10,000,000) = 0.20
2016 ROI = ($2,400,000/$25,000,000) × ($25,000,000/$15,000,000) = 0.16
Corporate management was disappointed in the performance of the division for 2016, since it had made
an additional investment in the division that was budgeted for a 23% ROI.
Required:
a. Discuss some factors that may have contributed to the decrease in ROI for 2016.
b. Would there have been any substantial difference if average capital had been used?
71) ROI, RI, or EVA measures are more appropriate than ROS to measure the performance of a company.
Why?
Objective 23.3
Answer the following questions using the information below:
Home Decor Inc., manufactures home cleaning products. The company has two divisions, Bleach and
Cleanser. Because of different accounting methods and inflation rates, the company is considering
multiple evaluation measures. The following information is provided for 2015:
ASSETS
Book value
Current value
Book value
Current value
Bleach
$275,000
$300,000
$125,000
$150,000
Cleanser
$400,000
$350,000
$100,000
$115,000
The company is currently using a 15% required rate of return.
1) What are Bleach’s and Cleanser’s return on investment based on book values, respectively?
A) 0.25; 0.67
B) 0.42; 0.52
C) 0.52; 0.47
D) 0.46; 0.25
2) What are Bleach’s and Cleanser’s return on investment based on current values, respectively?
A) 0.22; 0.6749
B) 0.42; 0.5219
C) 0.50; 0.3286
D) 0.67; 0.2286
3) What are Bleach’s and Cleanser’s residual incomes based on book values, respectively?
A) $83,750; $40,000
B) $110,000; $67,500
C) $67,500; $110,000
D) $81,500; $40,250
Answer the following questions using the information below:
Carriage Incorporated manufactures horse carriages. The company has two divisions, Wheels and
Assembly. Because of different accounting methods and inflation rates, the company is considering
multiple evaluation measures. The following information is provided for 2015:
ASSETS
Book value
Current value
Book value
Current value
Wheels
$485,000
$550,000
$120,000
$140,000
Assembly
$750,000
$1,200,000
$160,000
$172,500
The company is currently using a 12% required rate of return.
4) What are Wheels’s and Assembly’s return on investment based on book values, respectively?
A) 0.21; 0.25
B) 0.25; 0.21
C) 0.14; 0.25
D) 0.25; 0.14
5) What are Wheels’s and Assembly’s return on investment based on current values, respectively?
A) 0.21; 0.25
B) 0.25; 0.21
C) 0.14; 0.25
D) 0.25; 0.14
6) What are Wheels’s and Assembly’s residual incomes based on book values, respectively?
A) $74,000; $28,500
B) $61,800; $70,000
C) $63,500; $59.500
D) $28,500; $74,000
7) The cost today of purchasing an asset identical to the one currently held is called a(n) ________.
A) actual cost
B) current cost
C) prime cost
D) variable cost
8) The proponents of using net book value as an investment base maintain that it is less confusing
because it is consistent with the amount of total assets shown in the conventional balance sheet.
9) Current cost return on investment is a better measure of the current economic returns from an
investment than historical cost return on investment.
10) The net present value of all cash flows over the life of an investment equals the net present value of
the
residual incomes.
11) Total assets employed is the total assets available minus the sum of idle assets and assets purchased
for future expansion.
12) Using net book value as an investment base will result in a lower ROI than using gross book value as
an investment base.
13) An important element in designing accounting-based performance measures is choosing the time
horizon of the performance measures. Discuss.
Objective 23.4
1) When managers set and measure target levels of performance and feedback, ________.
A) the historical-cost-based accounting measures are usually adequate for evaluating economic returns
on new investments
B) the historical-cost ROIs cannot be used to evaluate current performance
C) the timing of feedback is not dependent on the sophistication of the organization’s information
technology
D) the timing of feedback depends on the specific level of management receiving the feedback
2) Historical-cost-based accounting measures are usually inadequate for evaluating economic returns on
new investments and, in some cases, create disincentives for expansion.
3) What are the factors involved in choosing the timing of the feedback in designing accounting-based
performance measures?
4) What targets should companies use, and when should they give feedback to managers regarding their
performance relative to the targets?