Exam 14: Business Unit Performance Measurement

One disadvantage of using after-tax income as a performance measure of divisional results is that it is an absolute measure which makes it difficult to compare divisions of significantly different sizes.

The Dry Wall Division reports the following operating data for the past two years: Year 1 Year 2 Margin 16\% ? Turnover 2.5 2.0 Average operating assets ? \ 150,000 Net operating income \ 40,000 ? Stockholders' equity \ 80,000 \ 125,000 Sales ? ? - The return on investment at the Dry Wall Division was exactly the same in Year 1 and Year 2. Sales in Year 2 amounted to:

Which of the following statements regarding the use of historical costs and current costs to compute return on investment (ROI) is(are) true? (A) Historical costs are based on the original costs to acquire a long-term asset, while current costs represent the costs to replace the long-term asset. (B) For a specific multiple-period project, the return on investment (ROI) computed using current costs will generally be less than the ROI computed using historical costs.

The following information was presented by User-Friendly Industries Company for an asset purchased at the beginning of the previous year. Original cost of the asset \ 20,000 Useful life of the asset 10 years Annual operating profit, including depreciation \ 4,000 Salvage value \ -0- What is the return on investment (ROI) assuming User-Friendly uses (a) the straight-line method for depreciation and (b) beginning-of-year net book values to compute ROI?

One division of the Marvin Educational Enterprises has depreciable assets costing $4,000,000. The cash flows from these assets for the past three years have been: Year Cash flows 1 1,200,000 2 \ 1,400,000 3 \ 1,620,000 The current (i.e., replacement) costs of these assets were expected to increase 25% each year. -Marvin used the straight-line depreciation method and the estimated useful life is 10-years with no salvage value. For return on investment (ROI) calculations, Marvin uses end-of-year balances. What is the residual income for each year, assuming the cost of capital is 15% and Marvin uses historical costs and gross book values to compute residual income? Year 1 Year 2 Year 3 A) \ 200,000 \ 400,000 \ 620,000 B) \ 200,000 \ 200,000 \ 200,000 C) \ 250,000 \ 200,000 \ 450,000 D) \ 250,000 \ 400,000 \ 375,000

One division of the Marvin Educational Enterprises has depreciable assets costing $4,000,000. The cash flows from these assets for the past three years have been: Year Cash flows 1 1,200,000 2 \ 1,400,000 3 \ 1,620,000 The current (i.e., replacement) costs of these assets were expected to increase 25% each year. -Marvin used the straight-line depreciation method and the estimated useful life is 10-years with no salvage value. For return on investment (ROI) calculations, Marvin uses end-of-year balances. What is the residual income for each year, assuming the cost of capital is 15% and Marvin uses historical costs and net book values to compute residual income? Year 1 Year 2 Year 3 A) \ 200,000 \ 435,000 \ 690,000 B) \ 260,000 \ 520,000 \ 800,000 C) \ 260,000 \ 420,000 \ 540,000 D) \ 280,000 \ 400,000 \ 750,000

Kevin Thomas is the general manager of the Modular Homes Division, and his performance is measured using the residual income method. Thomas is reviewing the following forecasted information for his division for next year: (CMA adapted) Category Amount (thousands) Working capital \ 1,800 Reverue 30,000 Plant and equipment 17,200 If the cost of capital is 15% and Thomas wants to achieve a residual income target of $2,000,000, what will costs have to be in order to achieve the target?

The Parts Division of the Stein Corporation had average operating assets of $150,000 and net operating income of $27,800 in March. The company uses residual income to evaluate the performance of its divisions, with a minimum required rate of return of 17%. Required: What was the Parts Division's residual income in March?

A division earning a profit will increase its return on investment (ROI) if it increases operating expenses and:

Nue Wines has the following data for its three divisions for the year: Ein Zwei Drei Revenues \ 12,000,000 \3 8,000,000 \2 8,000,000 Cost of sales 7,695,000 19,000,000 14,000,000 Allocated corporate overhead 720,000 2,280,000 2,100,000 Other general \& administration 1,585,000 11,000,000 11,000,000 Return on Investment 15\% 12\% 9\% Required: a. Compute divisional operating income for each of the divisions. Assume taxes are 35%. b. Calculate the profit margin ratio for each division. c. Calculate the asset turnover for each division.

How does EVA differ from residual income?

The Dry Wall Division reports the following operating data for the past two years: Year 1 Year 2 Margin 16\% ? Turnover 2.5 2.0 Average operating assets ? \ 150,000 Net operating income \ 40,000 ? Stockholders' equity \ 80,000 \ 125,000 Sales ? ? - The return on investment at the Dry Wall Division was exactly the same in Year 1 and Year 2. Average operating assets in Year 1 were:

Treating research and development costs as an expense rather than a long-term asset may reduce a manager's inclination to participate in research and development activities.

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

The following information has been gathered for the Brake Division: Sales \ 420,000 Operating income \ 75,000 Average eurrent assets \ 260,000 Cost of capital 12\% Return on investment 15\% What is the Brake Division's residual income?

Mrs. Young is the manager of the Children's Toy division of Ferguson Corporation. Every year she just misses the cut off established by the company for the awarding of bonuses. She is concerned inasmuch as she believes she is running her division effectively and her income has been increasing slowly but steadily over the years she has been with the company. She knows that the company uses ROI as the performance measure to evaluate divisions and begins to study the formula to see what she should do to improve the ROI for her division. Required: Briefly discuss several ways to improve ROI.

Suade Inc. manufactures furniture and is organized into three large divisions: bedroom, living room, and dining room furniture. The following information presents operating revenues, operating incomes and invested assets of the company over the last three years. (all amounts in 000s) Operating Revenues 2020 2021 2022 Dining Room \8 ,000 \1 5,000 \1 6,000 Living Room 4,500 3,600 2,400 Bedroom 8,800 7,600 6,600 Operating Income Dining Room \2 ,500 \3 ,100 \1 ,800 Living Room 450 900 600 Bedroom 1,200 1,500 1,600 Invested Assets Dining Room \1 2,000 \1 2,500 \1 2,500 Living Room 2,500 2,400 2,200 Bedroom 4,500 4,700 4,900 The following table shows the number of managers covered by the current compensation package of Suade Inc.: Number of Managers 2020 2021 2022 Dirnirng Roorm 300 350 375 Living Room 40 40 37 Bedroom 120 140 175 The current compensation package is an annual bonus award. The managers share in the bonus pool. The pool is calculated as 12% of the annual residual income of the company. The residual income is defined as operating income minus an interest charge of 15% of invested assets. Required: (1) Use asset turnover, profit margin ratio, and ROI to explain the differences in profitability of the three divisions. (2) Compute the bonus amount to be paid during each year. Also, compute the (average) individual executive bonus amounts. (3) If the bonus was calculated by divisional residual income what would be the bonus amounts? (4) Discuss the benefits and problems of basing the bonus on residual income of a company compared to using divisional residual income.

La Mesa Stores has the following data for its two divisions for the year: Uno Dos Revenues \ 6,000,000 \ 18,000,000 Cost of sales 3,769,500 9,400,000 Allocated corporate overhead 400,000 1,200,000 Other general \& administration 772,000 5,700,000 Return n Tnrestment 14\% 12\% Required: a. Compute divisional operating income for each of the divisions. Assume taxes are 35%. b. Calculate the profit margin ratio for each division. c. Calculate the asset turnover for each division.

Last year, a company had stockholders' equity of $160,000, net operating income of $16,000, and sales of $100,000. The asset turnover was 0.5 and the return on investment (ROI) was:

Which of the following statement(s) is/are true? (A) If a division's return on investment (ROI) exceeds its cost of capital, then its residual income is positive. (B) If a division's cost of capital equals its return on investment (ROI), then its residual income is zero.