Chapter 11
Performance Measurement in Decentralized
Organizations
Solutions to Questions
11-1 In a decentralized organization,
decision-making authority isn’t confined to a few
top executives; instead, decision-making
authority is spread throughout the organization.
11-2 The benefits of decentralization include:
(1) by delegating day-to–day problem solving to
lower-level managers, top management can
concentrate on bigger issues such as overall
strategy; (2) empowering lower-level managers
11-3 The manager of a cost center has
control over cost, but not revenue or the use of
11-4 Margin is the ratio of net operating
income to total sales. Turnover is the ratio of
11-5 Residual income is the net operating
income an investment center earns above the
company’s minimum required rate of return on
operating assets.
11-6 If ROI is used to evaluate performance,
a manager of an investment center may reject a
profitable investment opportunity whose rate of
return exceeds the company’s required rate of
return but whose rate of return is less than the
investment center’s current ROI. The residual
income approach overcomes this problem
11-8 An MCE of less than 1 means that the
production process includes non-value-added
11-9 A company’s balanced scorecard should
be derived from and support its strategy.
11–10 The balanced scorecard is constructed
to support the company’s strategy, which is a
Exercise 11-1 (10 minutes)
1.
Net operating income
2.
Sales
Turnover = Average operating assets
$18,000,000
= = 0.5
$36,000,000
Exercise 11-2 (10 minutes)
Average operating assets ………………….
£2,200,000
Net operating income ……………………….
Exercise 11-3 (20 minutes)
2.8 days + 0.5 days + 0.7 days + 4.0 days
=
8.0 days
2. Only process time is value-added time; therefore the manufacturing
cycle efficiency (MCE) is:
3. If the MCE is 35%, then 35% of throughput time was spent in value-
added activities, the other 65% was spent in non-value-added activities.
4.
Delivery cycle time
=
Wait time + Throughput time
=
16.0 days + 8.0 days
=
24.0 days
5. If all queue time is eliminated, then the throughput time drops to only 4
days (0.5 + 2.8 + 0.7). The MCE becomes:
Exercise 11-4 (45 minutes)
1. MPC’s previous manufacturing strategy was focused on high-volume
production of a limited range of paper grades. The goal of this strategy
was to keep the machines running constantly to maximize the number
of tons produced. Changeovers were avoided because they lowered
2. Employees focus on improving those measures that are used to evaluate
their performance. Therefore, strategically-aligned performance
measures will channel employee effort towards improving those aspects
of performance that are most important to obtaining strategic
Exercise 11-4 (continued)
3. Students’ answers may differ in some details from this solution.
Average
+
Sales
Contribution
margin per ton
Financial
Time to fill
an order
Customer satisfaction with
breadth of product offerings
Number of new
customers acquired
Customer
–
+
+
+
+
Exercise 11-4 (continued)
4. The hypotheses underlying the balanced scorecard are indicated by the
arrows in the diagram. Reading from the bottom of the balanced
scorecard, the hypotheses are:
° If the number of employees trained to support the flexibility strategy
increases, then the average changeover time will decrease and the
increase.
° If the customer satisfaction with breadth of product offerings
increases, then the number of new customers acquired, sales, and
the contribution margin per ton will increase.
° If the number of new customers acquired increases, then sales will
Exercise 11-5 (20 minutes)
1.
(b)
(c)
Net
Average
(a)
Operating
Operating
ROI
Sales
Income*
Assets
(b) ÷ (c)
$4,500,000
$290,000
$800,000
36.25%
$4,600,000
$300,000
$800,000
37.50%
*Sales × Contribution Margin Ratio – Fixed Expenses
2. The ROI increases by 1.25% for each $100,000 increase in sales. This
happens because each $100,000 increase in sales brings in an additional
profit of $10,000. When this additional profit is divided by the average
Increase in sales ……………………………………………
Contribution margin ratio …………………………………
Average operating assets …………………………………
(d)
Increase in return on investment (c) ÷ (d) ………….
Exercise 11-6 (15 minutes)
1.
Net operating income
Margin = Sales
$800,000
= = 10%
$8,000,000
2.
Net operating income
Margin = Sales
$800,000(1.00 + 4.00)
=
$8,000,000(1.00 + 1.50)
$4,000,000
= = 20%
$20,000,000
Exercise 11-6 (continued)
3.
Net operating income
Margin = Sales
$800,000 + $250,000
=
$8,000,000 + $2,000,000
$1,050,000
= = 10.5%
$10,000,000
Exercise 11-7 (20 minutes)
1. ROI computations:
Net operating income Sales
ROI = ×
Sales Average operating assets
2.
Perth
Darwin
Average operating assets ………………..
$3,000,000
$10,000,000
Net operating income …………………….
$630,000
$1,800,000
Residual income …………………………...
$150,000
3. No, the Darwin Division is simply larger than the Perth Division and for
this reason one would expect that it would have a greater amount of
Exercise 11-8 (15 minutes)
Company A
Company B
Company C
Sales …………………………………..
$400,000
*
$750,000
*
$600,000
*
Net operating income ……………..
$32,000
$45,000
*
$24,000
Average operating assets ………..
$160,000
*
$250,000
$150,000
*
Return on investment (ROI) …….
*
*
Minimum required rate of return:
*
*
*
Residual income ……………………
*
Exercise 11-9 (30 minutes)
1. Computation of ROI.
Division A:
$300,000 $6,000,000
ROI = × = 5% × 4 = 20%
$6,000,000 $1,500,000
2.
Division A
Division B
Division C
Average operating assets …..
$1,500,000
$5,000,000
$2,000,000
Required rate of return ……..
× 15%
× 18%
× 12%
Minimum required return …..
Actual net operating income .
240,000
Residual income ………………
Exercise 11-9 (continued)
3.
a. and b.
Division A
Division B
Division C
Return on investment (ROI) …
20%
18%
9%
Therefore, if the division is
presented with an
investment opportunity
yielding 17%, it probably
would…………………………...
Reject
Reject
Accept
15%
18%
Therefore, if the division is
presented with an
investment opportunity
yielding 17%, it probably
would…………………………...
Reject
Accept
If performance is being measured by ROI, both Division A and Division B
probably would reject the 17% investment opportunity. The reason is
that these companies are presently earning a return greater than 17%;
thus, the new investment would reduce the overall rate of return and
place the divisional managers in a less favorable light. Division C
probably would accept the 17% investment opportunity, because its
acceptance would increase the Division’s overall rate of return.
Exercise 11-10 (15 minutes)
1. ROI computations:
Net operating income Sales
ROI = ×
Sales Average operating assets
2. The manager of the Western Division seems to be doing the better job.
Although her margin is three percentage points lower than the margin
of the Eastern Division, her turnover is higher (a turnover of 3.5, as
compared to a turnover of two for the Eastern Division). The greater
turnover more than offsets the lower margin, resulting in a 21% ROI, as
compared to an 18% ROI for the other division.
Exercise 11-11 (45 minutes)
1. Students’ answers may differ in some details from this solution.
Customer
+
Percentage of job
Revenue per employee
Sales
Profit margin
Financial
Ratio of billable hours
to total hours
Average number of
errors per tax return
Average time needed to
prepare a return
Internal Business
Processes
+
–
+
+
+
–
Exercise 11-11 (continued)
2. The hypotheses underlying the balanced scorecard are indicated by the
arrows in the diagram. Reading from the bottom of the balanced
scorecard, the hypotheses are:
° If the amount of compensation paid above the industry average
increases, then the percentage of job offers accepted and the level of
employee morale will increase.
prepare a return should decrease.
° If employee morale increases, then the ratio of billable hours to total
hours should increase while the average number of errors per tax
return and the average time needed to prepare a return should
decrease.
° If employee morale increases, then the customer satisfaction with
service quality should increase.
Exercise 11-11 (continued)
Each of these hypotheses can be questioned. For example, Ariel’s
customers may define effectiveness as minimizing their tax liability
which is not necessarily the same as minimizing the number of errors in
a tax return. If some of Ariel’s customers became aware that Ariel
3. The performance measure “total dollar amount of tax refunds
generated” would motivate Ariel’s employees to aggressively search for
tax minimization opportunities for its clients. However, employees may
be too aggressive and recommend questionable or illegal tax practices