Chapter 12
Decentralization and Performance Evaluation
QUESTIONS
1. Four advantages are:
(a) Subunit managers have better information than top management,
2. Two disadvantages are:
3. Some managers prefer exercising control over a greater number of employees and
4. Because subunits operate as relatively independent entities, they often perform
5. As subunit managers are given authority to make decisions, they tend to work
6. Cost centers, profit centers, and investment centers are responsibility centers.
7. EVA (economic value added) is essentially residual income with some adjustments
8. Financial measures of performance are “backward looking” in the sense that they
9. Note that other measures may be appropriate.
Financial—ROI, growth in sales
10. Using market price as a transfer price allows both buying and selling divisions to
Chapter 12 Decentralization and Performance Evaluation
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EXERCISES
E1. [LO 2]
Interest expense is a charge for capital (specifically, capital provided by debt
E2. [LO 2]
Noninterest-bearing current liabilities are subtracted because they are a free
E3. [LO 1]
E4. [LO 1]
E5. [LO 1]
Because the customer service centers are not charged with responsibility for
E6. [LO 1]
Because the director has the decision-making authority for operating the facility
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E7. [LO 2]
E8. [LO 2]
NOPAT
= Net income + Interest expense – Tax savings related to the
interest expense
=
$20,840,000
ROI
= NOPAT ÷ Invested capital
= $20,840,000 ÷ $199,000,000
=
NOPAT
= Net income + Interest expense – Tax savings related to the
interest expense
= Net income + interest expense (1 – tax rate)
= $6,435,000 + $1,000,000 (1 – .35)*
E9. [LO 2]
= $6,000,000 + $2,250,000 (1 – .4)
=
= Total assets – non interest-bearing current liabilities
= $80,000,000 – $6,700,000
=
$73,300,000
= NOPAT – (Cost of capital × Invested capital)
= $7,350,000 – (.10 × $73,300,000)
=
E10. [LO 2]
NOPAT
= Net income + Interest expense – Tax savings related to the
interest expense
= Net income + interest expense (1 – tax rate)
NOPAT
= Net income + Interest expense – Tax savings related to the
interest expense
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E11. [LO 2]
E12. [LO 2]
a. Senior managers at Quantum increased profit while ROI slipped from 17.7% to
12.6%. They increased profit by taking on investments that earned a low
Division 1
ROI
= NOPAT ÷ Invested capital
= $12,000,000 ÷ ($69,000,000-$4,500,000)
=
Residual Income/EVA
= NOPAT – (Cost of capital x Invested capital)
= $12,000,000 – (.11 × $64,500,000)
=
Division 2
E13. [LO 2]
Income from operations $ 126,900,000
Add current period R&D 15,600,000
E14. [LO 3]
Financial measures report the effect of past management decisions, just as a rear
view mirror reflects what a car has left behind. A car driver has to look ahead for
E15. [LO 3]
Customer-focused measures (among other possibilities):
Customer retention (i.e., percent of customers who renew memberships)
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E16. [LO A1]
The lab is organized as a profit center. Therefore, it should be allowed to charge
E17. [LO A1]
Under the proposed transfer pricing policy, the container plant will generate a
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PROBLEMS
P1. [LO 1, 3]
a. Budgets provide benchmarks for evaluating different plant operations, and
P2. [LO 1, 2]
P3. [LO 2]
a.
2017 2018
Net income $3,300,000 $3,426,000
P4. [LO 2]
a.
2017
2018
Net income
$ 770,000
$ 880,000
Plus interest
2,310,000
330,000
Less tax effect of interest
NOPAT
$2,156,000
$1,078,000
Total assets
Investment
NOPAT
$2,156,000
$1,078,000
Residual income
P5. [LO 2]
a.
b. As shown by the calculations in part a, if no new investment is made, ROI
Year 1
Year 2
Year 3
Year 4
Year 5
P6. [LO 2]
a.
2017
2018
Net income
$3,650,000
$4,950,000
Plus interest
2,420,000
2,975,000
Less tax effect of interest
(968,000)
(1,190,000)
NOPAT
$5,102,000
$6,735,000
Total assets
$59,500,000
$56,430,000
Less noninterest-bearing
4,400,000
4,950,000
Investment
$55,100,000
$51,480,000
b.
Profit margin (NOPAT ÷ Sales)
2017
2018
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P7. [LO 2, 3]
a.
Hazardous Residential
Waste Waste
Net income $1,870,000 $6,600,000
b.
Hazardous Residential
Waste Waste
P8. [LO 2]
a. Under GAAP, research and development is treated as an expense even though
it creates future value. Managers may be tempted to cut back on research and
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b.
Amortization
Unamortized
Year
Cost
2016
2017
2018
Amount
Amortization over three years
Net income $6,050,000
Plus interest 1,320,000