24-21
E24-17 Using ROI and RI to evaluate investment centers
Learning Objective 4
1. Residential’s ROI 32.50%
Zoes, a national manufacturer of lawn-mowing and snow-blowing equipment, segments its business
according to customer type: professional and residential. The following divisional information was
available for the past year:
Management has a 23% target rate of return for each division.
Requirements
1. Calculate each division’s ROI. Round all of your answers to four decimal places.
2. Calculate each division’s profit margin ratio. Interpret your results.
3. Calculate each division’s asset turnover ratio. Interpret your results.
4. Use the expanded ROI formula to confirm your results from Requirement 1. What can you
conclude?
24-22
SOLUTION
Requirement 1
Average total assets
Requirement 2
Profit margin ratio
=
=
=
=
Requirement 3
Asset turnover ratio
=
Net sales
Average total assets
Residential’s
asset turnover ratio
=
$540,000
=
3.0000
$180,000
=
$380,000
24-23
E24-17, cont.
Requirement 4
Profit
margin ratio
×
Asset
turnover ratio
=
ROI
Residential Division
10.83%
×
3.000
=
0.3249 = 32.49%
Professional Division
14.21%
×
=
0.4001 = 40.01%
Note: Exercise E24-17 must be completed before attempting Exercise E24-18.
E24-18 Using ROI and RI to evaluate investment centers
Learning Objective 4
Professional’s RI $64,600
Refer to the data in Exercise E24-17. Calculate each division’s RI. Interpret your results.
SOLUTION
RI
=
Operating income
–
(Target rate of return × Average total assets)
=
–
=
–
=
=
$152,000
–
=
$152,000
–
=
$ 64,600
24-24
E24-19 Determining transfer pricing
Learning Objective 5
The Watkins Company is decentralized, and divisions are considered investment centers. Watkins
specializes in sports equipment, and one division manufactures netting that is used for basketball hoops,
soccer goals, and other sports equipment. The Netting Division reports the following information for a
heavy-duty basketball hoop net:
The Basketball Equipment Division can purchase a similar heavy-duty net from an outside vendor for
$15.
Requirements
1. Determine the negotiable range for the transfer price.
2. What is the minimum transfer price the Netting Division should consider if operating at capacity?
Below capacity?
3. What is the maximum transfer price the Basketball Equipment Division should consider?
SOLUTION
Requirement 1
Requirement 2
The minimum transfer price the Netting Division should consider, if operating at capacity, is $18. If they
Requirement 3
The maximum transfer price the Basketball Equipment Division should consider is $15.
24-25
Problems (Group A)
P24-20A Integrating decentralization and performance evaluation systems
Learning Objectives 1, 2, 3
1. Sales $24,000 F
One subunit of Field Sports Company had the following financial results last month:
Requirements
1. Complete the performance evaluation report for this subunit (round to two decimal places).
2. Based on the data presented and your knowledge of the company, what type of responsibility center
is this subunit?
24-26
SOLUTION
Requirement 1
Subunit X
Actual
Results
Flexible
Budget
Flexible
Budget
Variance
(F or U)
% Variance
(F or U)
Requirement 2
The performance report includes both revenue and cost data; therefore, this subunit must be a profit
center.
Requirement 3
The only item meeting the criteria of exceeding $4,000 and 10% is the Traceable Fixed Expenses.
Requirement 4
Requirement 5
The flexible budget variances are not due to sales volume differences between budget and actual.
P24-20A, cont.
Requirement 6
Requirement 7
Requirement 8
Student’s responses will vary, but may include:
Perspective
Common Key Performance Indicators (KPIs)
Customer
• Customer satisfaction ratings
• Percentage of market share
• Increase in number of customers
24-28
P24-21A Using ROI and RI to evaluate investment centers
Learning Objective 4
3. Asset turnover ratio 18.00
Consider the following condensed financial statements of Safe Money, Inc. The company’s target rate of
return is 20%.
Requirements
1. Calculate the company’s ROI. Round all of your answers to four decimal places.
2. Calculate the company’s profit margin ratio. Interpret your results.
3. Calculate the company’s asset turnover ratio. Interpret your results.
4. Use the expanded ROI formula to confirm your results from Requirement 1. Interpret your results.
5. Calculate the company’s RI. Interpret your results.
24-29
SOLUTION
Requirement 1
Requirement 2
Profit margin ratio
=
Requirement 3
Asset turnover ratio
=
Net sales
Average total assets
Requirement 4
Profit margin
ratio
×
Asset turnover
ratio
=
ROI
0.9000 = 90.0%
24-30
P24-21A, cont.
Requirement 5
RI
=
Operating income
–
(Target rate of return × Average total assets)
–
–
P24-22A Using ROI and RI to evaluate investment centers
Learning Objective 4
4. Paint Stores’s ROI 34.16%
Bear Paints is a national paint manufacturer and retailer. The company is segmented into five divisions:
Management has specified a 21% target rate of return.
Requirements
1. Calculate each division’s ROI. Round all of your answers to four decimal places.
2. Calculate each division’s profit margin ratio. Interpret your results.
3. Calculate each division’s asset turnover ratio. Interpret your results.
4. Use the expanded ROI formula to confirm your results from Requirement 1. Interpret your results.
5. Calculate each division’s RI. Interpret your results, and offer a recommendation for any division
with negative RI.
6. Describe some of the factors that management considers when setting its minimum target rate of
return.
24-31
SOLUTION
Requirement 1
ROI
=
Operating income
Average total assets
=
= 0.3416 = 34.16%
Requirement 2
Profit margin ratio
=
=
P24-22A, cont.
Requirement 4
Profit
margin ratio
×
Asset
turnover ratio
=
ROI
0.3416 = 34.16%
0.1177 = 11.77%
Requirement 5
RI
=
Operating income
–
(Target rate of return × Average total assets)
–
(21% × $1,405,000)
–
–
(21% × $1,580,000)
–
P24-22A, cont.
Requirement 6
Management may have different minimum target rates of return for different divisions. For example,
24-33
P24-23A Determining transfer pricing
Learning Objective 5
2. Total CM $124,200
The Costa Company is decentralized, and divisions are considered investment centers. Costa has one
division that manufactures oak dining room chairs with upholstered seat cushions. The Chair Division
cuts, assembles, and finishes the oak chairs and then purchases and attaches the seat cushions. The
Chair Division currently purchases the cushions for $18 from an outside vendor. The Cushion Division
manufactures upholstered seat cushions that are sold to customers outside the company. The Chair
Division currently sells 1,800 chairs per quarter, and the Cushion Division is operating at capacity,
which is 1,800 cushions per quarter. The two divisions report the following information:
Requirements
1. Determine the total contribution margin for Costa Company for the quarter.
2. Assume the Chair Division purchases the 1,800 cushions needed from the Cushion Division at its
current sales price. What is the total contribution margin for each division and the company?
3. Assume the Chair Division purchases the 1,800 cushions needed from the Cushion Division at its
current variable cost. What is the total contribution margin for each division and the company?
4. Review your answers for Requirements 1, 2, and 3. What is the best option for Costa Company?
5. Assume the Cushion Division has capacity of 3,600 cushions per quarter and can continue to supply
its outside customers with 1,800 cushions per quarter and also supply the Chair Division with 1,800
cushions per quarter. What transfer price should Costa Company set? Explain your reasoning. Using
the transfer price you determined, calculate the total contribution margin for the quarter.
SOLUTION
Requirement 1
Contribution Margin
for the Quarter
Units
×
Contribution
Margin per Unit
=
Total
Contribution
Margin
24-34
P24-23A, cont.
Requirement 2
Contribution Margin
for the Quarter
Units
×
Contribution
Margin per Unit
=
Total
Contribution
Margin
Requirement 3
Contribution Margin
for the Quarter
Units
×
Contribution
Margin per Unit
=
Total
Contribution
Margin
Requirement 4
The best option for Costa is the current scenario. By having the Chair Division purchase the cushions
Requirement 5
Costa Company should set the transfer price at $16 to $18, the range of the variable cost to the outside
price. The total contribution margin does not change for the whole company when the transfer price
Units
×
=
24-35
Problems (Group B)
P24-24B Integrating decentralization and performance evaluation systems
Learning Objectives 1, 2, 3
1. CM $15,000 F
One subunit of Zone Sports Company had the following financial results last month:
Requirements
1. Complete the performance evaluation report for this subunit (round to two decimal places).
2. Based on the data presented and your knowledge of the company, what type of responsibility center
is this subunit?
3. Which items should be investigated if part of management’s decision criteria is to investigate all
variances equal to or exceeding $6,000 and exceeding 10% (both criteria must be met)?
4. Should only unfavorable variances be investigated? Explain.
5. Is it possible that the variances are due to a higher-than-expected sales volume? Explain.
6. Will management place equal weight on each of the variances exceeding $6,000? Explain.
7. Which balanced scorecard perspective is being addressed through this performance report? In your
opinion, is this performance report a lead or a lag indicator? Explain.
8. List one key performance indicator for the three other balanced scorecard perspectives. Make sure to
indicate which perspective is being addressed by the indicators you list.
24-36
SOLUTION
Requirement 1
Subunit X
Actual
Results
Flexible
Budget
Flexible
Budget
Variance
(F or U)
% Variance
(F or U)
Sales
$ 479,000
$ 451,000
$ 28,000 F
6.21% F
Variable Expenses
Contribution Margin
7.50% F
Traceable Fixed Expenses
40,000
Divisional Segment Margin
$ 175,000
$ 172,000
1.74% F
Requirement 2
Requirement 3
The only item meeting the criteria of exceeding $6,000 and 10% is the Traceable Fixed Expenses.
Requirement 4
Requirement 5
The flexible budget variances are not due to sales volume differences between budget and actual.
24-37
P24-24B, cont
Requirement 6
Requirement 7
The performance report addresses the financial perspective of the balanced scorecard. Financial
performance measures tend to be lag indicators. They typically measure the results of past decisions.
Requirement 8
Student’s responses will vary, but may include:
Perspective
Common Key Performance Indicators (KPIs)
Customer
• Customer satisfaction ratings
• Percentage of market share
24-38
P24-25B Using ROI and RI to evaluate investment centers
Learning Objective 4
2. Profit margin ratio 10.00%
Consider the following condensed financial statements of Sure Life, Inc. The company’s target rate of
return is 30%.
Requirements
1. Calculate the company’s ROI. Round all of your answers to four decimal places.
2. Calculate the company’s profit margin ratio. Interpret your results.
3. Calculate the company’s asset turnover ratio. Interpret your results.
4. Use the expanded ROI formula to confirm your results from Requirement 1. Interpret your results.
5. Calculate the company’s RI. Interpret your results.
24-39
SOLUTION
Requirement 1
Requirement 2
Profit margin ratio
=
Requirement 3
Asset turnover ratio
=
Net sales
Average total assets
Requirement 4
Return on Investment
=
Profit margin
ratio
×
Asset turnover
ratio
10.00%
×
6.0000
=
0.6000 = 60.00%
24-40
P24-25B, cont.
Requirement 5
P24-26B Using ROI and RI to evaluate investment centers
Learning Objective 4
3. Consumer’s asset turnover ratio 0.8076
Benjamin Doore is a national paint manufacturer and retailer. The company is segmented into five
Requirements
1. Calculate each division’s ROI. Round all of your answers to four decimal places.
2. Calculate each division’s profit margin ratio. Interpret your results.
3. Calculate each division’s asset turnover ratio. Interpret your results.
4. Use the expanded ROI formula to confirm your results from Requirement 1. Interpret your results.
5. Calculate each division’s RI. Interpret your results, and offer a recommendation for any division
with negative RI.
6. Describe some of the factors that management considers when setting its mini- mum target rate of
return.