Exercise 10.19
1. The value of the option for the entire amount would be:
2. Advantages: Ownership of stock may encourage the executives to take a
longer-term perspective, and it may make them conscious of the overuse of
perquisites.
10–16
CPA-TYPE EXERCISES
Exercise 10.20
Exercise 10.21
b.
Exercise 10.22
d.
Exercise 10.23
Exercise 10.24
b.
Weight Rate Product
60% × 7.1% = 4.26%
PROBLEMS
Problem 10.25
1. Minimum transfer price = $3.45
2. Yes, since the variable cost of the transistor is $2.00 ($2.75 less the $0.75 of
3. The negotiated price of $11.00 provides profit for both the Board and Sys-
tems divisions. The Board Division realizes a profit of $1.70 per board ($11.00
Problem 10.26
1. Keimer Steel Company
Unit Contribution Margin
For the Year Ended November 30, 2015
Sales revenue …………………………………………. $ 25,000,000
Less variable costs:
2. a. ROI = Income before taxes/Average operating assets*
= $1,845,000/$12,300,000
10–18
Problem 10.26 (Concluded)
b. Residual income = $1,845,000 – (0.13 × $12,300,000)
3. The management of Keimer Steel would have been more likely to accept the
contemplated capital acquisition if residual income were used as the perfor-
mance measure because the investment would have increased both the divi-
sion’s residual income and the management bonuses. Using residual income,
4. Keimer must be able to control all items related to profits and investment if it
is to be evaluated fairly as an investment center using either ROI or residual
Problem 10.27
If Lawanna accepts the new position, she will earn $66,000 (salary of $50,000 and
bonus of $16,000) in Year 1. After two years, if Shasta’s stock rises at the same
rate as it has over the past five years, she will be able to exercise her stock option
and realize a gain of the following:
Price of stock in two years ($15 × 1.16 × 1.16 × 10,000) …………… $201,840
Exercise price of stock ………………………………………………………….. 150,000
Problem 10.27 (Concluded)
The final decision rests on Lawanna’s assessment of the risk versus reward of
the two positions. She should also consider the risk of remaining in her present
position; that is, what are her prospects for making partner at the professional
services firm?
Problem 10–28
1. Part 4CM Model 7AC Company
Sales ……………………………… $ 64,500* $ 580,000** $644,500
2. The transfer price should be the market price of $12. This is the minimum
3. Unless the manager of the Small AC Division is able to increase the price of
Model 7AC, he will discontinue production and will not purchase any of the
Problem 10.29
1. Santigui should not reduce the price charged to Ashleigh if he can sell all he
produces at a price of $4.75 per pound. Ashleigh should buy externally, sav-
2. Coffee Division:
Gross profit if Donut Division buys from Coffee:
= Sales – Variable cost of goods sold – Fixed overhead
= (950,000 × $4.75) – (950,000 × $2.12) – (1,000,000 × $1.53)
= $968,500
3. Maximum transfer price (set by Donut Division) = $4.30
Minimum transfer price (set by Coffee Division) = $2.12
Note that the maximum transfer price is the external price offered to the Do-
nut Division, and the minimum transfer price is the variable cost of the Coffee
Division. The proposed transfer price is $3.30 ($4.30 – $1.00) and is accepta-
10–21
Problem 10.29 (Concluded)
4. Original Income New Income
Sales:
External ……………….. $4,037,500 $4,037,500
Internal ………………… 475,000 $4,512,500 330,000 $4,367,500
Variable cost ……………. 2,014,000 2,014,000
Problem 10.30
1. $320
2. Minimum: $296
3. Potential gain per unit = $290 – $98 = $192
Share of gain to each division = $192/2 = $96
Transfer price = $98 + $96 = $194
Problem 10.31
1. The segment information prepared for public reporting purposes may not be
appropriate for the evaluation of segment management performance be-
cause:
• An allocation of common costs incurred for the benefit of more than one
segment must be included for public reporting purposes.
2. If their performance is evaluated on the basis of the information in the annual
financial report, Webster Corporation’s segment managers may become frus-
3. Webster Corporation should define responsibility centers that coincide with
managers’ actual responsibilities rather than using the segment rules devel-
Problem 10.32
1. a. Meyers Service Company 2014 bonus pool:
Bonus pool = 10% × Income before taxes and bonus
b. Wellington Products, Inc., 2014 bonus pool:
Bonus pool = 1% × (Revenues – Cost of product)
= 0.01 × ($10,000,000 – $4,950,000)
Problem 10.32 (Continued)
2. a. Two of the advantages and two of the disadvantages to Renslen, Inc., of
the bonus pool incentive plan at Meyers Service Company are as follows:
Advantages:
The management team will be motivated by the bonus plan as they have
the opportunity to earn additional compensation if they work hard as a
team and take some risks for the company.
b. Two of the advantages and two of the disadvantages to Renslen, Inc., of
the bonus pool incentive plan at Wellington Products, Inc., are as follows:
Advantages:
The management team will be motivated by the bonus plan as each man-
ager has the opportunity to earn additional compensation by working
hard and taking some risks for the company.
10–24
Problem 10.32 (Concluded)
3. a. Having two different incentive plans for the two operating divisions could
result in behavioral problems and may reduce teamwork/synergy between
the two divisions if the managers of either division believe they are being
treated unfairly.
The management team at Meyers Service Company may believe that they
have to work harder to achieve their bonuses as they are responsible for
b. In order to justify having different incentive plans for the two divisions,
Renslen, Inc., could argue that:
The goals and products of the businesses are different (one is a service
organization while the other is a manufacturing organization) and, there-
Problem 10.33
1. If Mason Industries continues to use return on investment as the sole meas-
ure of division performance, JSC would be reluctant to acquire RLI because
the combined return on investment would decrease.
10–25
Problem 10.33 (Concluded)
2. If Mason Industries could be persuaded to use residual income to measure
performance, JSC would be more willing to acquire RLI because the residual
3. The likely effect on the behavior of division managers whose performance is
measured by:
a. Return on investment includes considerations to: put off capital im-
provements or modernization to avoid capital expenditures, and shy
Problem 10.34
1. $200, because it could purchase the motor externally for that price.
3. The environmental factor most important to this decision is the governmental
prohibition against layoffs. This could turn direct labor into a strictly fixed
10–26
Problem 10.35
1. Fred turned down the proposed investment as the ROI from the investment is
2. The iron should have been manufactured since the company’s income would
3. Yes. The project has a residual income of $48,000 and accepting it would
4. Residual income encourages managers to invest in projects that increase a
firm’s income, decreasing the likelihood that profitable investments will be
5. Since ROI is the main performance measure, Fred was not willing to accept a
profitable investment because it would decrease his division’s ROI. Facing a
possible promotion, he chose to maintain the division’s high ROI rather than
earn extra profits for the company. The decision was motivated by self-
10–27
CYBER RESEARCH CASE
10.36
Answers will vary.
The following problems can be assigned within CengageNOW and are auto-
graded. See the last page of each chapter for descriptions of these new assign-
ments.
• Analyzing Relationships—Review concepts of Return on Investment and Re-
sidual Income to understand underlying variables.
• Analyzing Relationships—Determine the relevant costs/benefits related to