Exam 12: Performance Evaluation and Decentralization

Basically,EVA is residual income with the cost of capital equal to the minimum rate of return for the firm.

The following information pertains to the three divisions of Borraw Company: Division A Division B Sales ? 1,250,000 Net operating income \ 25,000 \ 75,000 Average operating assets ? ? Return on investment 20\% 15\% Margin 0.05 ? Turnover ? ? Target ROI 12\% 10\% -Refer to the Figure.What are the average operating assets for Division B?

The following information pertains to the three divisions of Zorro Company: What is the residual income for Division A? Division A Division B Division C Sales ? ? 1,250,000 Net operating income \ 40,000 \ 25,000 \ 75,000 Average operating assets 400,000 ? ? Return on investment ? 20\% 15\% Margin 0.10 0.05 ? Tumover 1.2 ? ? Target ROI 14\% 12\% 10\%

Division A produces a component and wants to sell it to Division B.Which of the following best describes the relationship of the transfer price to Division A and Division B?

Suppose the International Division of National Products Company had a turnover ratio of 5.2 and a margin of 0.10.What would be the return on investment?

Alpha Division had the following information: Suppose the asset base is decreased by $200,000,with no other changes.What would be the return on investment of Alpha Division? Asset base in Alpha Division \ 800,000 Net income in Alpha Division \ 100,000 Cost of capital 12\% Target ROI 15\% Margin for Alpha Division 20\%

Giga-Stuff, Inc. has a number of divisions. One division, Sophistosand, makes component X, which is used in the manufacture of DVD players. Another division, Videostuff, makes DVD players and needs 60,000 units of component X per year. Sophistosand incurs the following costs for one unit of component X: Sophistosand has the capacity to make 400,000 units of component X per year but, due to a soft market, plans to produce and sell only 320,000 units next year. Videostuff currently buys component X from an outside supplier for $2.50 each (the same price that Sophistosand receives). Direct materials \ 0.30 Direct labour 0.15 Variable overhead 0.70 Fixed overhead 1.00 Total \ 2.15 -Refer to the Figure.Assume that Sophistosand and Videostuff have agreed on a transfer price of $2.20.What are the total cost savings for Videostuff?

Return on investment (ROI)is the most common measure of performance for a revenue centre.

What is the term for the strategic management system that translates an organization's mission and strategy into operational objectives and performance measures?

How is residual income calculated?

Why is decentralization frequently chosen by companies?

The selling division is forced to transfer a product internally when a cost-based transfer pricing policy is set by top management.

Suppose the operating asset turnover increased by 75% and the margin increased by 50%.What would be the percentage increase in the ROI?

Using return on investment to calculate residual income,the dollar cost of capital employed is the actual percentage cost of capital multiplied by the total capital.

The Wood Parts Division of Alpha Company sells all of its output to the Finishing Division of the company.The only product of the Wood Parts Division is chair legs that are used by the Finishing Division.The retail price of the legs is $20 per leg.Each chair completed by the Finishing Division requires four legs.Production quantity and cost data are as follows: Required: Compute the transfer price for a chair leg using: Number of chair legs produced each year 30,000 Direct materials \ 135,000 Direct labour \ 90,000 Factory overhead (25\% is variable) \ 90,000 A. Market price B. Variable product costs plus a fixed fee of $20 \%$ C. Full cost plus $20 \%$ markup D. Variable costs

Last year,Western Division had a ROI of 15%.The manager of the Western Division is considering an additional investment for the coming year.What step will the manager likely choose to take?

What is the term for the number of units of output that can be produced in a given period of time?

What is the variable set by top management when calculating residual income?

Decreasing inventories leads to a reduction in return on investment (ROI).

Residual income is sometimes used to overcome the tendency of ROI to discourage investments that are profitable for the company but that lower the division's ROI.