Deck 14: Business Unit Performance Measurement

Question 1

Residual income is the difference between the divisional income and the cost of invested capital required to operate the division.

Answer 1

True

Question 2

Using net book values instead of gross book values to compute return on investment (ROI)might encourage an investment center manager to delay replacing inefficient assets until they are fully depreciated.

Answer 2

True

Question 3

The profit margin ratio is computed by dividing after-tax operating income by sales.

Answer 3

True

Question 4

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

Question 5

In general,a division's investment base includes an allocated share of the corporate headquarters' assets.

Question 6

Current costs should not be used to compute either return on investment (ROI)or residual income because current costs are not generally accepted accounting principles (GAAP).

Question 7

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

Question 8

It is not possible for a manager to accept an unacceptable project when his/her performance is evaluated using ROI.

Question 9

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

Question 10

One advantage of using after-tax income as a performance measure of divisional results is it's a financial accounting measure that is also used to compute the organizational income.

Question 11

In general,it is better to have a higher return on investment (ROI)than a lower one.

Question 12

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

Question 13

One problem with economic value added (EVA)adjustments is determining the appropriate life for expenditures that benefit multiple periods.

Question 14

Divisional income statements do not have to follow generally accepted accounting principles (GAAP)because they are internal reports.

Question 15

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.

Question 16

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.

Question 17

Economic value added (EVA)adjustments are made to both the after-tax income and the capital employed.

Question 18

A problem with ratio-based measures is that managers can make decisions that improve divisional income but lower total organizational income.

Question 19

Most organizations use residual income instead of return on investment (ROI)as a performance measure.

Question 20

Managerial myopia is the distortion in incentives that result from using accounting measures to evaluate performance.

Question 21

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

A)current assets.
B)working capital.
C)total assets available.
D)total assets employed.
E)based on historical costs.

Question 22

A manager can always increase his/her return on investment (ROI)by

A)reducing the asset turnover.
B)decreasing residual income.
C)increasing the operating profit margin.
D)expanding operating assets while holding sales and expenses constant.

Question 23

Managerial performance can be measured in many different ways including return on investment (ROI)and residual income.A good reason for using residual income instead of ROI is that

A)Residual income can be computed without regard to identifying an investment base.
B)Appropriate goal congruence behavior is more likely to occur when using residual income.
C)Residual income is well accepted in many organizations and often used in the financial press.
D)ROI does not take into consideration both the investment turnover ratio and return-on-sales percentage.
E)An imputed interest rate (cost of capital)does not have to be determined when using residual income.

Question 24

The measure (ratio)that reflects the performance of a manager regarding sales and cost of goods sold,but not other operating costs and income taxes,is called the

A)gross margin ratio.
B)profit margin ratio.
C)operating margin ratio.
D)contribution margin ratio.

Question 25

Which of the following items would not be an example of an economic value added (EVA)adjustment to eliminate accounting distortions?

A)Research & development costs
B)Advertising expenditures
C)Patent amortization
D)Common stock

Question 26

After-tax income divided by sales is called the

A)gross margin ratio.
B)profit margin ratio.
C)operating margin ratio.
D)contribution margin ratio.

Question 27

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.

A)only (A)is true
B)only (B)is true
C)both (A)and (B)are true
D)neither (A)and (B)is true

Question 28

Which of the following should not be used for the cost of capital to compute residual income?

A)Historical weighted average cost of capital.
B)Marginal after-tax cost of new equity capital.
C)Cost of debt and equity used to finance a project.
D)Return on investment (ROI).

Question 29

Which one of the following items would most likely not be incorporated into the calculation of a division's investment base when using the residual income approach for performance measurement and evaluation?

A)Land being held by the division as a potential site for a new plant and parking lot.
B)Division inventories when division management exercises control over the inventory levels.
C)Division accounts payable when division management exercises control over the amount of short-term credit utilized.
D)Division accounts receivable when division management exercises control over credit policy and credit terms.

Question 30

Which of the following statement(s)is/are false? (A)Residual income can be used to compare divisions of different sizes.
(B)Residual income can be used to compare divisions that are profit centers.

A)only (A)is false
B)only (B)is false
C)both (A)and (B)are false
D)neither (A)and (B)is false

Question 31

The asset turnover is a measure (ratio)of an investment center's ability to

A)earn profits.
B)generate sales.
C)control costs.
D)remain solvent.

Question 32

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.

A)accountants'
B)manager's
C)shareholder's
D)economist's
E)financial analyst's

Question 33

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

A)sales by the same dollar amount.
B)sales by the same percentage.
C)investment by the same dollar amount.
D)investment by the same percentage.

Question 34

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.

A)Only A is true.
B)Only B is true.
C)Both A and B are true.
D)Neither A nor B is true.

Question 35

Return on investment (ROI)can be decomposed into the asset turnover and the

A)gross margin ratio.
B)profit margin ratio.
C)operating margin ratio.
D)contribution margin ratio.

Question 36

How will decreases in the following items affect return on investment (ROI)?

A)a
B)b
C)c
D)d

Question 37

How will decreases in the following items affect residual income?

A)a
B)b
C)c
D)d

Question 38

Which of the following statements does not represent a limitation of using return on investment (ROI)for measuring and evaluating performance?

A)ROI uses accounting income which is based on historical costs.
B)ROI cannot be used to compare divisions of different sizes.
C)ROI has the potential to create goal congruence problems.
D)ROI fails to align some costs incurred in one period with the benefits received in another period.

Question 39

How will increases in the following items affect return on investment (ROI)?

A)a
B)b
C)c
D)d

Question 40

How will increases in the following items affect residual income?

A)a
B)b
C)c
D)d

Question 41

Rayburn Corporation purchased a new machine for $120,000.The machine has an estimated useful life of 10-years with no salvage value and a return on investment (ROI)of 15%.ROI is computed using annual cash flows and straight-line depreciation.What is the annual cash flow using the gross book value method?

A)$12,200
B)$18,000
C)$28,200
D)$30,000

Question 42

The following information was presented by Gamma Manufacturing Company for an asset purchased at the end of the previous year. What is the return on investment (ROI)assuming Gamma (a)uses the straight-line method for depreciation and (b)beginning-of-year net book values to compute ROI?

A)11.1%
B)20.0%
C)10.0%
D)22.2%

Question 43

Economic value added (EVA)assumes that which of the following GAAP expenses would not result in an adjustment to either the income or the capital employed?

A)Research & development costs
B)Use of process costing rather than job costing
C)Advertising expenses
D)Writeoff of goodwill

Question 44

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

A)historical costs and net book values.
B)historical costs and gross book values.
C)current costs and net book values.
D)current costs and gross book values.

Question 45

The following information was presented by Delta Manufacturing Company for an asset purchased at the end of the previous year. What is the return on investment (ROI)assuming Delta (a)uses the straight-line method for depreciation and (b)beginning-of-year net book values to compute ROI?

A)11.1%
B)20.0%
C)22.2%
D)25.0%

Question 46

In 2008,Wishbone Corporation had an operating profit of $750,000 and a residual income of $300,000.If Wishbone's cost of capital is 15%,what is the amount of the invested capital?

A)$5,000,000
B)$3,000,000
C)$2,000,000
D)$1,250,000

Question 47

Which of the following items would not require an adjustment to capital employed when using economic value added (EVA)?

A)Research & development costs
B)Advertising expenditures
C)Preferred stock
D)Patents developed

Question 48

Which division has the largest asset turnover?

A)South
B)West
C)East
D)All three divisions are the same

Question 49

The FGH 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%.What was the company's operating profit margin?

A)5.0%
B)6.0%
C)6.7%
D)8.3%

Question 50

The FGH 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?

A)6.0%
B)10.0%
C)15.0%
D)20.0%

Question 51

Welsh Corporation's return on investment (ROI)on some new equipment was 20% using beginning-of-year net book value.The gross book value of the equipment is $250,000.Accumulated depreciation at the beginning of the year was $10,000.This represents one-half year's straight-line depreciation.What is the annual before-tax cash flow from the new equipment?

A)$68,000
B)$60,000
C)$48,000
D)$20,000

Question 52

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.

A)only (A)is true
B)only (B)is true
C)both (A)and (B)are true
D)neither (A)and (B)is true

Question 53

Which division's profit margin is the highest?

A)South
B)West
C)East
D)All three divisions are the same

Question 54

Economic value added (EVA)is a concept that is closely related to residual income.EVA is computed by

A)subtracting the adjusted total cost of capital from the adjusted after-tax income.
B)subtracting adjusted after-tax income from total divisional investment.
C)dividing adjusted after-tax income by adjusted divisional investment.
D)dividing adjusted after-tax income by adjusted total cost of capital.

Question 55

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

A)early in the year and dispose of assets late in the year.
B)early in the year and dispose of assets early in the year.
C)late in the year and dispose of assets late in the year.
D)late in the year and dispose of assets early in the year.

Question 56

The Najacht Division of the Rassbach Company has a return on investment (ROI)of 12%,sales of $200,000,and an asset turnover of 2.0.What was Najacht's operating income?

A)$6,000
B)$12,000
C)$24,000
D)$48,000

Question 57

The following information was presented by Charlie Manufacturing Company for an asset purchased at the beginning of the previous year. What is the return on investment (ROI)assuming Charlie (a)uses the straight-line method for depreciation and (b)average net book values to compute ROI?

A)21.1%
B)20.0%
C)22.2%
D)11.76%

Question 58

The following information is available for Company X: What is Company X's return on investment (ROI)?

A)6.0%
B)10.0%
C)15.0%
D)24.0%

Question 59

Which division has the smallest return on investment (ROI)?

A)South
B)West
C)East
D)All three divisions are the same

Question 60

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

A)early in the year and dispose of assets late in the year.
B)early in the year and dispose of assets early in the year.
C)late in the year and dispose of assets late in the year.
D)late in the year and dispose of assets early in the year.

Question 61

What is the residual income for each year,assuming the cost of capital is 15% and RST uses historical costs and gross book values to compute residual income?

A)a
B)b
C)c
D)d

Question 62

What was A Division's residual income last year?

A)$12,000.
B)$22,500.
C)$30,000.
D)$48,000.

Question 63

What is the ROI using current costs and net book value?

A)a
B)b
C)c
D)d

Question 64

What was B Division's return on investment (ROI)last year?

A)16.00%.
B)20.00%.
C)24.00%.
D)33.75%.

Question 65

Which one of the following items would most likely not be incorporated into the calculation of a division's investment base when using the residual income approach for performance measurement and evaluation? (CMA Adapted)

A)Fixed assets employed in division operations.
B)Land being held by the division as a site for a new plant.
C)Division inventories when division management exercises control over the amount of short-term credit used.
D)Division accounts payable when division management exercises control over the amount of short-term credit used.

Question 66

Return on investment (ROI)is a very popular measure employed to evaluate the performance of corporate segments because it incorporates all of the major ingredients of profitability (revenue,cost,investment)into a single measure.Under which one of the following combinations of actions regarding a segment's revenues,costs,and investment would a segment's ROI always increase? (CIA adapted)

A)a
B)b
C)c
D)d

Question 67

The following information is available for Company X: What is Company X's residual income?

A)$2,000
B)$2,500
C)$3,500
D)$4,000

Question 68

What is the ROI using historical cost and gross book value?

A)a
B)b
C)c
D)d

Question 69

Residual income is a better measure for performance evaluation of an investment center manager than return on investment (ROI)because (CMA adapted)

A)the problems associated with measuring the asset base are eliminated.
B)desirable investment decisions will not be neglected by high return divisions.
C)only the gross book value of assets needs to be calculated.
D)returns do not increase as assets are depreciated.
E)the arguments over the cost of capital are eliminated.

Question 70

The following information pertains to Bala Co.for the year ended December 31: (CPA adapted) Which of the following equations should be used to compute Bala's return on investment (ROI)?

A)(4/6) $\times$ (6/1)= ROI
B)(6/4) $\times$ (1/6)= ROI
C)(4/6) $\times$ (1/6)= ROI
D)(6/4) $\times$ (6/1)= ROI

Question 71

What was C Division's cost of capital last year?

A)8%.
B)12%.
C)18%.
D)20%.

Question 72

The following information has been gathered for the Green Division: Compute the Green Division's residual income.

A)$1,800
B)$2,700
C)$3,600
D)$5,400

Question 73

If sales each year average $840,000,what will be the asset turnover using gross book value?

A)3.0
B)2.6
C)2.1
D)1.9

Question 74

What is the ROI for each year using net book value?

A)a
B)b
C)c
D)d

Question 75

A firm earning a profit can increase its return on investment by (CMA adapted)

A)increasing sales revenue and operating expenses by the same dollar amount.
B)decreasing sales revenues and operating expenses by the same percentage.
C)increasing investment and operating expenses by the same dollar amount.
D)increasing sales revenues and operating expenses by the same percentage.

Question 76

Use the following information to compute residual income:

A)$12,000
B)$22,500
C)$30,000
D)$48,000

Question 77

What is the residual income for each year,assuming the cost of capital is 15% and RST uses historical costs and net book values to compute residual income?

A)a
B)b
C)c
D)d

Question 78

What is the ROI using historical cost and net book value?

A)a
B)b
C)c
D)d

Question 79

What is the ROI using current costs and gross book value?

A)a
B)b
C)c
D)d

Question 80

What is the ROI for each year using gross book value?

A)a
B)b
C)c
D)d