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CHAPTER 10: DIVISIONAL PERFORMANCE MEASUREMENT Multiple Choice c Both ROI and RI can be used for performance evaluation of a cost centers b profit centers c investment centers d all of the above b The best transfer price is usually a actual cost plus a percentage markup b a reliable market price c budgeted full cost plus a percentage markup d budgeted variable cost plus a percentage markup d This year Division A made sales to Division B at a higher transfer price than was used last year All other things equal, which of the following is true? a A's profit this year should be about the same as last year b B's profit this year should be about the same as last year c The company's total profit should be higher this year than last year d The company's total profit should be about the same this year as last year b Goal congruence is especially relevant to all of the following EXCEPT a setting transfer prices for an artificial profit center b quoting prices for outside customers of an investment center c selecting costs to be included in performance reports d setting transfer prices for an investment center d For a division, ROI a is usually less than ROI for the company as a whole b eliminates the distortion that cost allocation can produce in other measures of performance c usually cannot be computed if divisional assets are valued at their replacement costs d is a performance measure inferior, for some purposes, to residual income a Divisional ROI is usually a higher than that for the company as a whole b lower than that for an outside company operating in the same industry c lower than return on sales for the division d lower than that for the enterprise as a whole 133 c Divisional profits should a exclude revenues and expenses related to dealings with other divisions within the same enterprise b be computed so that the total profits of all the divisions equals the total profit for the company c be based on the principle of controllability d be based on cash flows rather than accrual basis accounting c Divisional profit a is computed in essentially the same way as is income for the company as a whole b should include a deduction for an appropriate share of the company's common costs c normally includes the results of intracompany sales d is not affected by depreciation methods d Using replacement costs for assets in computing ROI and RI a is prohibited because it violates generally accepted accounting principles b will increase both ROI and RI for a division c is unfair to divisional managers d is less popular than the use of book values in those computations c 10 Using residual income for evaluating performance a penalizes managers whose segments have low ROIs b penalizes managers of relatively large segments c encourages managers to maximize dollars of profit after a required ROI has been achieved d encourages managers to maximize ROI for the company c 11 Which item is usually NOT relevant to a decision by a divisional manager to reduce a transfer price to meet a price offered to another division by an outside supplier? a Opportunity cost b Variable manufacturing costs c Fixed divisional overhead d The price offered by the outside supplier c 12 Division A earns $6,000 on an investment of $36,000 On an investment of $84,000, Division B earns $12,000 Which of the following is true? a Division A's profits are too low b If there are further costs that are common to both divisions, the total company's ROI is probably greater than 15% c If the minimum desired ROI is 10%, Division A's residual income is lower than that of Division B d ROI for Division B is greater than ROI for Division A d 13 Which equation describes ROI? (I = investment, S = sales, and N = income) a S/I b S/I x N c S/I x S/N d N/S x S/I 134 a 14 Which equation describes residual income? (I = investment, N = income, and K = minimum required ROI) a N - (K x I) b (K x I) - N c N/I - K d (K x I) - (N/I) c 15 If Division C has a 10% return on sales, income of $10,000, and an investment turnover of times, its sales are a $10,000 b $40,000 c $100,000 d $400,000 b 16 If Division C has a 10% return on sales, income of $10,000, and an investment turnover of times, divisional investment is a $10,000 b $25,000 c $40,000 d $100,000 c 17 If Division C has a 10% return on sales, income of $10,000, and an investment turnover of times, its ROI is a 5000% b 100% c 40% d 10% b 18 If a division's ROI and the minimum required ROI are the same, the division's residual income is a positive b zero c negative d none of the above a 19 If residual income for Division Q of Company Z is negative, which of the following is true? a Q's ROI is less than Z's minimum required ROI b Q's ROI equals Z's minimum required ROI c Q's ROI is higher than Z's minimum required ROI d None of the above b 20 Market-based transfer prices are best for a the company when the selling division is operating below capacity b the company when the selling division is operating at capacity c the buying division if it is operating at capacity d the buying division d 21 The worst transfer-pricing method is to base the prices on a market prices b budgeted variable costs c budgeted total costs d actual total costs 135 d 22 All other things remaining constant, if a division doubles its investment turnover, its ROI will a decrease b remain constant c increase d double c 23 Residual income a is always the best measure of divisional performance b is not as good a measure of performance as ROI c overcomes some of the problems associated with ROI d cannot be used by divisions that deal with others in the same company b 24 If two divisions earn the same ROI and RI, which of the following is true? a Their managers must be about equally skillful b Their incomes and investments must be the same c Both divisions are doing as well as they should be d All of the above c 25 Which of the following is most likely to be included in calculating divisional profit? a Interest on corporate debt b Income taxes c Sales to other divisions within the company d A share of corporate administration expenses b 26 If sales increase, while income and investment remain constant, which of the following is true? a Investment turnover decreases b ROS decreases c ROI increases d ROI could increase or decrease c 27 Compared to a jewelry store, a supermarket has a higher margin and higher turnover b higher margin and lower turnover c lower margin and higher turnover d lower margin and lower turnover c 28 If income increases while sales and investment remain constant, which of the following is true? a Investment turnover increases b ROS decreases c ROI increases d ROI could increase or decrease a 29 Which transfer price is ideal for the company when the selling division is at capacity? a Market price b Incremental cost c Budgeted full cost d Actual variable cost plus a percentage profit 136 137 c 30 From the standpoint of the company, the important question in transfer pricing is a what is fair to the divisions b how to determine the profit of the divisions c whether or not the transfer should take place d when the transfer should be made d 31 The ROI of Division A relative to that of Division B can be influenced by a the industry in which each division operates b the transfer price used for sales to Division B c the tax structures of the countries in which the divisions operate d all of the above c 32 Considering liabilities in computing divisional investment a encourages managers of divisions to pay their bills faster b discourages managers of divisions from acquiring long-term financing c raises divisional ROI above what it would otherwise be d is a bad managerial practice d 33 Interdivisional sales a lower the company's public image b minimize income taxes c are ignored when computing divisional ROI d none of the above a 34 Which of the following is true about transfer divisions located in different countries? a They should consider the tax structures in b They are usually set by the governments of c They cannot affect the total income of the d All of the above prices for sales between the two countries the two countries company d 35 Multinational companies face special problems in which of the following areas of managerial practice? a Performance evaluation b Transfer prices c Allocating common costs d All of the above b 36 Which of the following describes the computation of ROI? a Return on Sales x Investment b Investment Turnover x Return on Sales c Income - (Investment x Minimum RI) d Sales x Investment Turnover b 37 If the investment turnover increased by 20% and ROS decreased by 30%, the ROI would a increase by 20% b decrease by 16% c increase by 4% d none of the above 138 b 38 Scottso Division has the following results for the year: Revenues Variable expenses Fixed expenses $1,080,000 440,000 400,000 Total divisional assets are $1,600,000 The company's minimum required rate of return is 14 percent Residual income for Scottso is a $(64,000) b $16,000 c $151,200 d $224,000 c 39 Scottso Division has the following results for the year: Revenues Variable expenses Fixed expenses $1,080,000 440,000 400,000 Total divisional assets are $1,600,000 The company's minimum required rate of return is 14 percent Return on investment for Scottso is a 54% b 18% c 15% d 10% b 40 Monrovia Division has net income of $240,000 on sales of $3,200,000 If the investment is $1,600,000 what is ROS? a 15.0% b 7.5% c 10.0 d 2.0 c 41 Scottso Division has the following results for the year: Revenues Variable expenses Fixed expenses $1,080,000 440,000 400,000 Total divisional assets are $1,600,000 The company's minimum required rate of return is 14 percent Return on sales for Scottso is a 1.5% b 15.0% c 22.2% d 67.5% d 42 Monrovia Division has net income of $240,000 on sales of $3,200,000 If the investment is $1,600,000 what is asset turnover? a 15.0% b 7.5% c 10.0 d 2.0 139 a 43 Monrovia Division has net income of $240,000 on sales of $3,200,000 If the investment is $1,600,000 what is ROI? a 15.0% b 7.5% c 10.0 d 2.0 b 44 Alcatraz Division of XYZ Corp sells 80,000 units of part X to the outside market Part X sells for $40, has a variable cost of $22, and a fixed cost per unit of $10 Alcatraz has a capacity to produce 100,000 units per period Capone Division currently purchases 10,000 units of part X from Alcatraz for $40 Capone has been approached by an outside supplier willing to supply the parts for $36 What is the effect on XYZ's overall profit if Alcatraz REFUSES the outside price and Capone decides to buy outside? a no change b $140,000 decrease in XYZ profits c $80,000 decrease in XYZ profits d $40,000 increase in XYZ profits a 45 Alcatraz Division of XYZ Corp sells 80,000 units of part X to the outside market Part X sells for $40, has a variable cost of $22, and a fixed cost per unit of $10 Alcatraz has a capacity to produce 100,000 units per period Capone Division currently purchases 10,000 units of part X from Alcatraz for $40 Capone has been approached by an outside supplier willing to supply the parts for $36 What is the effect on XYZ's overall profit if Alcatraz ACCEPTS the outside price and Capone continues to buy inside? a no change b $140,000 decrease in XYZ profits c $80,000 decrease in XYZ profits d $40,000 increase in XYZ profits c 46 If the investment turnover decreased by 20% and ROS decreased by 30%, the ROI would a increase by 30% b decrease by 20% c decrease by 44% d none of the above c 47 If the investment turnover increased by 10% and ROS increased by 20%, the ROI would a increase by 10% b increase by 20% c increase by 30% d increase by 32% 140 b 48 Durand Division has the following results for the year: Revenues Net income $470,000 130,000 Total divisional assets are $625,000 The company's minimum required rate of return is 12 percent Residual income for Durand is a $3,760 b $55,000 c $73,600 d cannot be determined without further information c 49 Durand Division has the following results for the year: Revenues Net income $470,000 130,000 Total divisional assets are $625,000 The company's minimum required rate of return is 12 percent Return on investment for Durand is a 9.0% b 18.3% c 20.8% d 27.7% d 50 Durand Division has the following results for the year: Revenues Net income $470,000 130,000 Total divisional assets are $625,000 The company's minimum required rate of return is 12 percent Return on sales for Durand is a 9.0% b 18.3% c 20.8% d 27.7% True-False F Multinational companies cannot use transfer prices T Long-term debt is seldom considered in determining divisional ROI F The measure most commonly used for evaluating divisional performance is investment turnover T Allocating all common assets, liabilities, and costs to divisions does not affect the ROI of the company as a whole T Using residual income as a criterion for evaluating divisional performance requires that the company establish a minimum desired rate of return on investment F Return on investment is the product of return on sales and inventory 141 turnover 142 F Return on investment for a multidivision company will be lower than the ROI for the division with the lowest ROI T Transfer prices equal to market prices are least appropriate when the selling division has excess productive capacity F Multinational companies must use transfer prices based on actual costs F 10 Return on investment is defined as net income divided by stockholders' equity Problems The following information is available about the status and operations of A-Klop Company, which has a minimum required ROI of 15% ANSWER EACH ITEM INDEPENDENTLY OF THE OTHERS Division Division A B Divisional investment $ 500,000 $1,500,000 Divisional profit $ 150,000 $ 540,000 Divisional sales $1,000,000 $3,600,000 a Compute ROI for Division A b Compute residual income for Division B c Division A could increase its profit by $40,000 by increasing its investment by $150,000 Compute its total residual income d Division A could increase its return on sales by one percentage point, while keeping the same total sales and investment Compute its ROI e Division B could reduce its investment so that its asset turnover increased by one time, while holding total sales constant Compute its ROI SOLUTION: a ROI for A: 30% ($150,000/$500,000) b RI for B: $315,000 [$540,000 - ($1,500,000 x 15%)] c RI for A: [$150,000 + $40,000 - 15% x ($500,000 + $150,000)] $92,500 d ROI for A: 32% [$150,000/$1,000,000 = 15% ROS + 1% = 16%, turnover = ($1,000,000/$500,000), so 16% x = 32%] e ROI for B: 51% [$3,600,000/1,500,000 = 2.4 times + = 3.4 times x ROS of 15% ($540,000/$3,600,000) = 51%] 143 144 Division A of Getz Company expects the following results ANSWER EACH QUESTION INDEPENDENTLY To Division B To Outsiders -Sales (40,000 x $10) $400,000 (40,000 x $12) $480,000 Variable costs at $6 240,000 240,000 Contribution margin $160,000 $240,000 Fixed costs, all common, allocated on the basis of relative units 120,000 120,000 Profit $ 40,000 $120,000 ======== ======= Division B has the opportunity to buy its needs for 40,000 units from an outside supplier at $8 each a Division A refuses to meet the $8 price, sales to outsiders cannot be increased, and Division B buys from the outside supplier Compute the effect on the income of Getz b Division A cannot increase its sales to outsiders, does meet the $8 price, and Division B continues to buy from A Compute the effect on the income of Getz c Suppose that Division A could sell the 40,000 units now taken by Division B to outsiders at $9 each without disturbing sales at the regular $12 price Division B buys outside at $8 and Division A increases its outside sales Find the effect on the income of Getz SOLUTION: a Getz's income: Decreases $80,000 variable cost)] b Getz's income: [40,000 units x ($8 outside price - $6 No change c Getz's income: $40,000 increase ($360,000 added revenue from outsiders $320,000 paid to the outsider by B) The following information relates to Zimmer Division of Purdy Inc Purdy's desired ROI for its segments is 20% Sales $2,000,000 Direct fixed costs 300,000 Variable costs Investment a Find Zimmer's ROI b Find Zimmer's residual income 145 1,500,000 500,000 SOLUTION: a ROI: 40% [($2,000,000 - $1,500,000 - $300,000)/$500,000] b RI: $100,000 [$200,000 - ($500,000 x 20%)] Bayfield Division of Ashland Inc has a capacity of 200,000 units and expects the following results Sales (160,000 units at $4) Variable costs, at $2 Fixed costs Income $640,000 (320,000) (260,000) -$ 60,000 ======== Washburn Division of Ashland Inc currently purchases 50,000 units of a part for one of its products from an outside supplier for $4 per unit Washburn's manager believes he could use a minor variation of Bayfield's product instead, and offers to buy the units from Bayfield at $3.50 Making the variation desired by Washburn would cost Bayfield an additional $0.50 per unit and would increase Bayfield's annual cash fixed costs by $20,000 BAYFIELD'S MANAGER AGREES TO THE DEAL OFFERED BY WASHBURN'S MANAGER a Find the effect of the deal on Washburn's income and circle the correct direction (increase decrease none) b Find the effect of the deal on Bayfield's income and circle the correct direction (increase decrease none) c Find the effect of the deal on the income of Ashland Inc and circle the correct direction (increase decrease none) SOLUTION: a Washburn's income, + $25,000 [50,000 x ($4 - $3.50)] b Bayfield's income, + $10,000 {50,000 x ($3.50 - $2 - $0.50) - [lost contribution margin of 10,000 x ($4 - $2)] - $20,000 new fixed costs} c Ashland's income, + $35,000 ($25,000 + $10,000) Crosby Division has the following information for the most recent period: Divisional income Divisional investment Divisional sales $ 1,500,000 $ 6,500,000 $12,000,000 Crosby has a minimum required return of 18% 146 a Compute Crosby's return on investment b Compute Crosby's investment turnover c Compute Crosby's residual income d Compute Crosby's return on sales SOLUTION: a ROI: 23.1% b IT: 1.85 ($1,500,000/$6,500,000) ($12,000,000/$6,500,000) c RI: $330,000 d ROS: 12.5% [$1,500,000 - (18% x $6,500,000)] ($1,500,000/$12,000,000) The following information is available about the status and operations of Stills Company, which has a minimum required ROI of 20% ANSWER EACH ITEM INDEPENDENTLY OF THE OTHERS Divisional investment Divisional profit Divisional sales Division A -$400,000 $120,000 $800,000 Division B -$1,250,000 $ 580,000 $2,600,000 a Compute ROI for Division B b Compute residual income for Division A c Division B could increase its profit by $80,000 by increasing its investment by $300,000 Compute its total residual income d Division A could increase its return on sales by one percentage point, while keeping the same total sales Compute its ROI e Division A could increase its sales so that its asset turnover increased by one time, while holding total assets constant Compute its ROI SOLUTION: a ROI for B: 46.4% ($580,000/$1,250,000) b RI for A: $20,000 c RI for B: d ROI for A: [$120,000 - ($400,000 x 20%)] $350,000 32% [$580,000 + $80,000 - 20% x ($1,250,000 + $300,000)] [$120,000/$800,000 = 15% ROS + 1% = 16%, turnover = 147 ($800,000/$400,000), so 16% x = 32%] e ROI for A: 45% [$800,000/400,000 = times + = times x ROS of 15% ($120,000/$800,000) = 45%] 148 Division A of Nash Company expects the following results ANSWER EACH QUESTION INDEPENDENTLY To Division B To Outsiders -Sales (5,000 x $60) $300,000 (25,000 x $72) $1,800,000 Variable costs at $36 180,000 900,000 -Contribution margin $120,000 $ 900,000 Fixed costs, all common, allocated on the basis of relative units 60,000 300,000 -Profit $ 60,000 $ 600,000 ======== ========== Division B has the opportunity to buy its needs for 5,000 units from an outside supplier at $45 each a Division A refuses to meet the $45 price, sales to outsiders cannot be increased, and Division B buys from the outside supplier Compute the effect on the income of Nash b Division A cannot increase its sales to outsiders, does meet the $45 price, and Division B continues to buy from A Compute the effect on the income of Nash c Suppose that Division A could sell the 5,000 units now taken by Division B to outsiders at $57 each without disturbing sales at the regular $72 price Division B buys outside at $45 and Division A increases its outside sales Find the effect on the income of Nash SOLUTION: a Nash's income: Decreases $45,000 variable cost)] b Nash's income: [5,000 units x ($45 outside price - $36 No change c Nash's income: $60,000 increase ($285,000 added revenue from outsiders $225,000 paid to the outsider by B) The following information relates to Bradley Division of Allen Company Allen's minimum cost of capital for its segments is 15% Sales $4,000,000 Direct fixed costs 1,800,000 Variable costs Investment a Find Bradley's ROI b Find Bradley's economic value added 149 1,400,000 4,800,000 SOLUTION: a ROI: 16.7% b EVA: $80,000 [($4,000,000 - $1,400,000 - $1,800,000)/$4,800,000] [$800,000 - ($4,800,000 x 15%)] Rosalie Division of Lachene Inc has a capacity of 100,000 units and expects the following results for Sales (90,000 units at $30) Variable costs, at $20 Fixed costs Income $2,700,000 (1,800,000) (700,000) $ 200,000 ========== Katarina Division of Lachene Inc currently purchases 20,000 units of a part for one of its products from an outside supplier at $32 per unit Katarina's manager believes he could use a minor variation of Rosalie's product instead, and offers to buy the units from Rosalie at $26 Making the variation desired by Katarina would cost Rosalie an additional $5 per unit and would increase Rosalie's annual cash fixed costs by $80,000 ROSALIE'S MANAGER AGREES TO THE DEAL OFFERED BY KATARINA'S MANAGER a Find the effect of the deal on Katarina's income and circle the correct direction (increase decrease none) b Find the effect of the deal on Rosalie's income and circle the correct direction (increase decrease none) c Find the effect of the deal on the income of Lachene Inc and circle the correct direction (increase decrease none) SOLUTION: a Katarina's income, + $120,000 [20,000 x ($32 - $26)] b Rosalie's income, - $160,000 {20,000 x ($26 - $20 - $5) - [lost contribution margin of 10,000 x ($30 - $20)] - $80,000 new fixed costs)} c Lachene's income, - $40,000 ($120,000 - $160,000) 10 Young Division has the following information for the most recent period: Divisional income Divisional investment Divisional sales $ 11,000,000 $ 85,000,000 $100,000,000 Young has a minimum required return of 15% a Compute Young's return on investment 150 b Compute Young's investment turnover c Compute Young's residual income d Compute Young's return on sales SOLUTION: a ROI: 12.9% b IT: 1.18 ($11,000,000/$85,000,000) ($100,000,000/$85,000,000) c RI: ($1,750,000) d ROS: 11.0% [$11,000,000 - (15% x $85,000,000)] ($11,000,000/$100,000,000) 151 ... decreased by 20% and ROS decreased by 30%, the ROI would a increase by 30% b decrease by 20% c decrease by 44% d none of the above c 47 If the investment turnover increased by 10% and ROS increased by. .. Turnover b 37 If the investment turnover increased by 20% and ROS decreased by 30%, the ROI would a increase by 20% b decrease by 16% c increase by 4% d none of the above 138 b 38 Scottso Division... increased by 10% and ROS increased by 20%, the ROI would a increase by 10% b increase by 20% c increase by 30% d increase by 32% 140 b 48 Durand Division has the following results for the year:
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