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Exam 14: Business Unit Performance Measurement

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Question 61

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Big Sky Industries is a division of a major corporation. The following data are for the latest year of operations: $\begin{array} { l r } \text { Sales } & \$ 12,700,000 \\\text { Net operating income } & \$ 1,054,100 \\\text { Average operating assets } & \$ 5,000,000\\\text { The company's minimum required rate of return }&16\%\end{array}$ Required: a. What is the division's return on investment (ROI)? b. What is the division's residual income?

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a. ROI = Net operating income ÷ Average ...

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Question 62

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The Country Garden Company's current net operating income is $16,800 and its average operating assets are $80,000. The Country Garden's required rate of return is 18%. A new project being considered would require an investment of $15,000 and would generate annual net operating income of $3,000. What is the residual income of the new project?

A) 20.8%.
B) 20%.
C) $(150) .
D) $300.

E) C) and D)
F) B) and C)

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Question 63

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Using beginning balances for the investment base in computing return on investment (ROI) might encourage managers to acquire assets:

The Pathways Company has an asset turnover of 3.0 times, using assets of $45,000. The company also has a return on investment (ROI) of 20%. If the residual income was $2,250, what was the company's cost of capital?

One problem associated with using accounting measures to evaluate divisional performance is the measures are based on historical information.

Residual income is similar to the ________ notion of profit as being the amount left over after all costs, including the cost of the capital employed in the division, are subtracted.

The use of residual income reduces, but does not eliminate, the suboptimization problem.

Which of the following statements is(are) true? (A) Divisional income statements do not include allocated common costs. (B) The gross margin ratio is computed by dividing operating income by sales.

The Butyl Division of the Swiss Corporation just started operations. It purchased depreciable assets costing $2,500,000 with an expected life of five years, after which the assets can be salvaged for $400,000. Depreciation is computed for the financial statements on a straight-line basis, using the salvage value. Annual operating cash flows are $1,300,000 for year 1. Assume that all cash flows and asset prices increase by 12.5% per year. Required: a. Compute the division's ROI for the first three years, using end of the year asset values, current costs, and net book values. b. Compute the division's ROI for the first three years, using end of the year asset values, current costs, and gross book values.

Roxie, Inc. has used a decentralized form of organizational structure for the past five years. The controller, Ms. Hamburg, has noticed that some of the divisions are still using fixed assets that are fully depreciated and that there has been little acquisition activity in these divisions. Coupled with this are very high ROIs, especially when compared to the other divisions that seem to have a regular program of disposition and replacement of fixed assets. She takes her concerns and observations to the Financial Vice President who says he will review her findings and look into the problem. Required: 1) What are the potential negative effects of decentralization? 2) Specifically discuss the issues involved in suboptimization.

The following information is available about the status and operations for Division A of Abad Company, which has a minimum required ROI of 20%. Answer each item independently of the others. $\begin{array} { l r } & \text { Division A } \\\text { Divisional investment } & \$ 100,000 \\\text { Divisional profit } & \$ 35,000 \\\text { Divisional sales } & \$ 200,000\end{array}$ Required: a. Compute the ROI for Division A. b. Compute the residual income for Division A. c. Division A could increase its profit by $8,000 by increasing its investment by $30,000. Compute its total residual income. d. Division A could increase its profit margin ratio by one percentage point (for example: from 12% to 13%), without increasing total sales or investment. Compute its new ROI. e. Division A could reduce its investment so that its asset turnover increased by one time, while holding total sales and profit constant. Compute its new ROI.

Financial data for Beaker Company for last year appear below: The company paid dividends of $2,100 last year. The "Investment in Cedar Company" on the statement of financial position represents an investment in the stock of another company. Required: a. Compute the company's margin, turnover, and return on investment for last year. b. The Board of Directors of Beaker Company has set a minimum required return of 20%. What was the company's residual income last year?

Edmonson Corporation had net operating income of $150,000 and average operating assets of $500,000. The company requires a return on investment of 19%. Required: a. Calculate the company's current return on investment and residual income. b. The company is investigating an investment of $400,000 in a project that will generate annual net operating income of $78,000. What is the return on investment of the project? What is the residual income of the project? Should the company invest in this project?

If a division is evaluated using return on investment (ROI) without regard to how assets are financed, the denominator in the ROI calculation will be:

In computing the margin in a ROI analysis, which of the following is used?

Level return on investments (ROI) over the life of a long-term project is more likely when ROI is computed using:

Which of the following is not an advantage of after-tax income as a performance measure?

The Labrador Falls Company has three divisions: A Division, B Division, and C Division. $\begin{array}{lcc}&\text {A}&\text {B}&\text {C}\\\text { Sales } & \$ 320,000 & \$ 540,000&?\\\text { Net operating income } & 60,000 & ?&\$24,000 \\\text { Residual income } & ? & 36,000&14,400 \\\text { Average Division Assets } & ? & ?&80,000 \\\text { Cost of Capital } & 12 \% & 16 \%&? \\\text { Profit Margin } & 20 \% & 5 \%&? \\\text { Asset Turnover } & ? & 4.0 &?\\\text { Return investment } & 15 \% & ?&?\end{array}$ - What was A Division's residual income last year?

Like return on investment (ROI), economic value added (EVA) adjustments fail to sufficiently address the suboptimization problem.

The following information is available about the status and operations for Division A of Boxwood Company, which has a minimum required ROI of 20%. Answer each item independently of the others. $\begin{array} { l r } & \text { Division A } \\\text { Divisional investment } & \$ 200,000 \\\text { Divisional profit } & \$ 70,000 \\\text { Divisional sales } & \$ 400,000\end{array}$ Required: a. Compute the ROI for Division A. b. Division A could increase its profit by $16,000 by increasing its investment by $60,000. Compute its new ROI. c. Division A could increase its profit margin ratio by one percentage point (for example: from 12% to 13%), without increasing total sales or investment. Compute its new ROI. d. Division A could reduce its investment so that its asset turnover increased by one time, while holding total sales and profit constant. Compute its new ROI.