Deck 13: Investment Centers and Transfer Pricing

Question 1

If the transfer price is set at the market price, the producing division should have the option of either producing goods for internal transfer or selling in the external market.

Answer 1

True

Question 2

Since most people exhibit risk aversion, managers must be compensated for the risk they must bear.

Answer 2

True

Question 3

Residual income facilitates goal congruence while ROI does not.

Answer 3

True

Question 4

What practice best describes when divisional managers throughout an organization work together to achieve the organization's goals?

A) Participatory management.
B) Goal attainment.
C) Goal congruence.
D) Centralization of objectives.
E) Negotiation by subordinates.

Question 5

The biggest challenge in making a decentralized organization function effectively is:

A) earning maximum profits through fair practices.
B) minimizing losses.
C) taking advantage of the specialized knowledge and skills of highly talented managers.
D) obtaining goal congruence among division managers.
E) developing an adequate budgetary control system.

Question 6

Which of the following performance measures is (are) used to evaluate the general financial success or failure of investment centers?

A) Residual income.
B) Return on investment.
C) Number of suppliers.
D) Economic value added.
E) All of these measures are used except number of suppliers.

Question 7

Improving ROI is a balancing act that requires all the skills of an effective manager.

Question 8

ROI is one performance measure that can motivate a manager to make decisions about costs he or she cannot control.

Question 9

The biggest challenge in making a decentralized organization function effectively is to obtain goal congruence among the organization's autonomous managers.

Question 10

A division's return on investment may be improved by increasing sales margin and cost of capital.

Question 11

One benefit of residual income is that it can be used to compare the performance of different-sized investment centers.

Question 12

Consider the following statements about goal congruence:
I) Goal congruence is obtained when managers of subunits throughout an organization strive to achieve the goals set by top management.
II) Managers are often more concerned about the performance of their own subunits rather than the performance of the entire organization.
III) Achieving goal congruence in most organizations is relatively straightforward and easy to accomplish.
Which of the above statements is (are) true?

A) I only.
B) II only.
C) I and II.
D) II and III.
E) I, II, and III.

Question 13

As an organization grows, however, its managers need less formal information systems, including managerial accounting information, in order to maintain control.

Question 14

Investment center performance measures and transfer prices are two internal controls that prevent dysfunctional decisions by mid-level managers.

Question 15

The maximization of profits of the buying division is one of the goals that should be pursued when setting transfer prices.

Question 16

The external market price transfer-pricing method can lead to dysfunctional decision-making behavior by managers.

Question 17

The income calculation for a division manager's ROI should be based on profit margin traceable to the division.

Question 18

Income divided by sales revenue is called capital turnover.

Question 19

ROI, residual income, and EVA are computed for a period of time.

Question 20

Economic value added uses a firm's weighted-average cost of capital.

Question 21

Which of the following is the correct mathematical expression for return on investment?

A) Sales margin/capital turnover.
B) Sales margin + capital turnover.
C) Sales margin - capital turnover.
D) Sales margin * capital turnover.
E) Capital turnover/ sales margin.

Question 22

Sales margin shows:

A) the amount of income generated by each dollar of capital investment.
B) the number of sales dollars generated by each dollar of capital investment.
C) the percentage of each sales dollar that remains as profit after all expenses are covered.
D) the amount of capital investment generated by each sales dollar.
E) the amount of capital investment generated by each dollar of income.

Question 23

A company's sales margin:

A) must, by definition, be greater than the firm's net sales.
B) has basically the same meaning as the term "contribution margin."
C) is computed by dividing sales revenue by income.
D) is computed by dividing income by sales revenue.
E) shows the sales dollars generated from each dollar of income.

Question 24

A division's return on investment may be improved by increasing:

A) cost of goods sold and expenses.
B) sales margin and cost of capital.
C) sales revenue and cost of capital.
D) capital turnover or sales margin.
E) capital turnover or cost of capital.

Question 25

Which of the following is used in the calculation of both return on investment and residual income?

A) Total stockholders' equity.
B) Retained earnings.
C) Invested capital.
D) Total liabilities.
E) The cost of capital.

Question 26

Jamison Company had sales revenue and operating expenses of $5,000,000 and $4,200,000, respectively, for the year just ended. If invested capital amounted to $6,000,000, the firm's ROI was:

A) 13.33%.
B) 83.33%.
C) 120.00%.
D) 750.00%.
E) None of the answers is correct.

Question 27

The information that follows relates to Khan Corporation:
Sales margin: 7.5%
Capital turnover: 2
Invested capital: $20,000,000
On the basis of this information, the company's sales revenue is:

A) $1,500,000.
B) $3,000,000.
C) $10,000,000.
D) $40,000,000.
E) None of the answers is correct.

Question 28

Beach Corporation has a return on investment of 15%. A Beach division, which currently has a 13% ROI and $750,000 of residual income, is contemplating a massive new investment that will (1) reduce divisional ROI and (2) produce $120,000 of residual income. If Beach strives for goal congruence, the investment:

A) should not be acquired because it reduces divisional ROI.
B) should not be acquired because it produces $120,000 of residual income.
C) should not be acquired because the division's ROI is less than the corporate ROI before the investment is considered.
D) should be acquired because it produces $120,000 of residual income for the division.
E) should be acquired because after the acquisition, the division's ROI and residual income are both positive numbers.

Question 29

Tempest Enterprises had a sales margin of 5%, sales of $4,000,000, and invested capital of $5,000,000. The company's ROI was:

A) 4.00%.
B) 6.25%.
C) 16.00%.
D) 25.00%.
E) None of the answers is correct.

Question 30

Capital turnover shows:

A) the income generated by each dollar of capital investment.
B) the sales dollars generated by each dollar of capital investment.
C) the contribution margin generated by each dollar of capital investment.
D) the capital investment generated by each sales dollar.
E) the capital investment generated by each dollar of income.

Question 31

The basic idea behind residual income is to have a division maximize its:

A) earnings per share.
B) income in excess of a corporate imputed interest charge.
C) cost of capital.
D) cash flows.
E) invested capital.

Question 32

Which of the following is not considered in the calculation of divisional ROI?

A) Divisional income.
B) Earnings velocity.
C) Capital turnover.
D) Sales margin.
E) Sales revenue.

Question 33

ROI is most appropriately used to evaluate the performance of:

A) cost center managers.
B) revenue center managers.
C) profit center managers.
D) investment center managers.
E) both profit center managers and investment center managers.

Question 34

All of the following actions are likely to increase ROI except:

A) an increase in sales revenues.
B) a decrease in operating expenses.
C) a decrease in a company's invested capital.
D) a decrease in the number of units sold.
E) an improvement in manufacturing efficiency.

Question 35

Consider the following statements about residual income:
I) Residual income incorporates a firm's cost of acquiring investment capital.
II) Residual income is a percentage measure, not a dollar measure.
III) If used correctly, residual income may result in division managers making decisions that are in their own best interest and not in the best interest of the entire firm.
Which of the above statements is (are) true?

A) I only.
B) II only.
C) I and II.
D) II and III.
E) I and III.

Question 36

The ROI calculation will indicate:

A) the percentage of each sales dollar that is invested in assets.
B) the sales dollars generated from each dollar of income.
C) how effectively a company used its invested capital.
D) the invested capital generated from each dollar of income.
E) the overall quality of a company's earnings.

Question 37

Which of the following is the correct mathematical expression to derive a company's capital turnover?

A) Sales revenue / invested capital.
B) Contribution margin /invested capital.
C) Income /invested capital.
D) Invested capital/ sales revenue.
E) Invested capital / income.

Question 38

The Holder Division of Extraordinary Enterprises has a negative residual income of $540,000. Holder's management is contemplating an investment opportunity that will reduce this negative amount to $400,000. The investment:

A) should be pursued because it is attractive from both the divisional and corporate perspectives.
B) should be pursued because it is attractive from the divisional perspective although not from the corporate perspective.
C) should be pursued because it is attractive from the corporate perspective although not from the divisional perspective.
D) should not be pursued because it is unattractive from both the divisional and corporate perspectives.
E) should not be pursued because it is unattractive from the divisional perspective although it is attractive from the corporate perspective.

Question 39

Vello, Inc. reported a return on investment of 12%, a capital turnover of 5, and income of $180,000. On the basis of this information, the company's invested capital was:

A) $300,000.
B) $900,000.
C) $1,500,000.
D) $7,500,000.
E) None of the answers is correct.

Question 40

The Nashville Division of Country Classics currently reports a profit of $3.6 million. Divisional invested capital totals $9.5 million; the imputed interest rate is 12%. On the basis of this information, Nashville's residual income is:

A) $432,000.
B) $708,000.
C) $1,140,000.
D) $2,460,000.
E) None of the answers is correct.

Question 41

The market value of Galleon's debt and equity capital totals $180 million, 80% of which is equity related. An analysis conducted by the company's finance department revealed a 7% after-tax cost of debt capital and a 10% cost of equity capital. On the basis of this information, Galleon's weighted-average cost of capital:

A) is 7.6%.
B) is 8.5%.
C) is 9.4%.
D) cannot be determined based on the data presented because the cost of debt capital must be stated on a before-tax basis.
E) cannot be determined based on the data presented because the cost of equity capital must be stated on an after-tax basis.

Question 42

Use the following information to answer the following Questions
The following information pertains to Travis Concrete:

The company's imputed interest rate is 8%.

-The ROI is:

A) 6%.
B) 15%.
C) 20%.
D) 30%.
E) 40%.

Question 43

Given that ROI measures performance over a period of time, invested capital would most appropriately be figured by using:

A) beginning-of-year assets.
B) average assets.
C) end-of-year assets.
D) total assets.
E) only current assets.

Question 44

The following information relates to the Falcon Division of Xenon Enterprises:

On the basis of this information, Falcon's weighted-average cost of capital is closest to:

A) 7.3%.
B) 8.3%.
C) 9.5%.
D) 10.8%.
E) None of the answers is correct.

Question 45

When an organization allows divisional managers to be responsible for short-term loans and credit, the division's invested capital should be measured by

A) total assets minus total liabilities.
B) average total assets minus average current liabilities.
C) average total assets minus average total liabilities.
D) average total liabilities minus average current assets.
E) average total liabilities minus total assets.

Question 46

Use the following information to answer the following Questions
The following information pertains to Travis Concrete:

The company's imputed interest rate is 8%.

-The capital turnover is:

A) 3.33.
B) 5.00.
C) 16.67.
D) 20.00.
E) 30.00.

Question 47

Use the following information to answer the following Questions
The following information pertains to Travis Concrete:

The company's imputed interest rate is 8%.

-For the period just ended, Global Industries' Western Division reported profit of $31.9 million and invested capital of $220 million. Assuming an imputed interest rate of 12%, which of the following choices correctly denotes Western's return on investment (ROI) and residual income?

Question 48

Which of the following elements is not used in the calculation of economic value added for an investment center?

A) An investment center's after-tax operating income.
B) An investment center's total assets.
C) An investment center's return on investment.
D) An investment center's current liabilities.
E) A company's weighted-average cost of capital.

Question 49

Which of the following elements is not used when calculating the weighted-average cost of capital?

A) Before-tax cost of debt capital.
B) After-tax cost of debt capital.
C) Cost of equity capital.
D) Market value of debt capital.
E) Market value of equity capital.

Question 50

Imputed interest can best be described as:

A) the company's weighted average cost of capital.
B) the prime interest rate on the date of the transaction.
C) the interest rate charged for the company's bonds.
D) the minimum required rate of return on invested capital.
E) the after-tax cost of the interest payments on debt.

Question 51

Foxmoor Corporation uses an imputed interest rate of 13% in the calculation of residual income. Division X, which is part of Foxmoor, had invested capital of $1,200,000 and an ROI of 16%. On the basis of this information, X's residual income was:

A) $24,960.
B) $36,000.
C) $156,000.
D) $192,000.
E) None of the answers is correct.

Question 52

The following information relates to the Corner Division of Hometown Enterprises:
Income for the period just ended: $1,500,000
Invested capital: $12,000,000
If the company has an imputed interest rate of 11%, Corner's residual income would be:

A) $165,000.
B) $180,000.
C) $187,500.
D) Some other dollar amount other than the ones given.
E) A percentage greater than 11%.

Question 53

Use the following information to answer the following Questions
The following information pertains to Travis Concrete:

The company's imputed interest rate is 8%.

-The sales margin is:

A) 6%.
B) 15%.
C) 20%.
D) 30%.
E) 40%.

Question 54

Economic value added (EVA) analysis indicates:

A) the amount of income generated by each dollar of capital investment.
B) the number of sales dollars generated by each dollar of capital investment.
C) the percentage of each sales dollar that remains as profit after all expenses are covered.
D) the amount of increased capital generated by each dollar of income.
E) how much shareholder wealth is being created.

Question 55

Which of the following measures of performance is, in part, based on the weighted-average cost of capital?

A) Return on investment.
B) Capital turnover.
C) Book value.
D) Economic value added (EVA).
E) Gross margin.

Question 56

The following information relates to Attor, Inc.:

If the company has a 10% weighted-average cost of capital, its economic value added would be:

A) $(200,000).
B) $530,000.
C) $680,000.
D) $970,000.
E) None of the answers is correct.

Question 57

Economic value added:

A) is a dollar amount rather than a percentage.
B) uses a firm's weighted-average cost of capital.
C) uses total assets in its computation and ignores current liabilities.
D) cannot be negative.
E) is both a dollar amount rather than a percentage and uses a firm's weighted-average cost of capital.

Question 58

Endotrope Corporation has an after-tax operating income of $3,200,000 and a 9% weighted-average cost of capital. Assets total $7,000,000 and current liabilities total $1,800,000. On the basis of this information, Endotrope's economic value added is:

A) $2,408,000.
B) $2,732,000.
C) $3,668,000.
D) $3,992,000.
E) None of the answers is correct.

Question 59

Use the following information to answer the following Questions
The following information pertains to Travis Concrete:

The company's imputed interest rate is 8%.

-The residual income is:

A) $30,000.
B) $36,000.
C) $42,000.
D) $54,000.
E) $82,800.

Question 60

Concert Division reported a residual income of $200,000 for the year just ended. The division had $8,000,000 of invested capital and $1,000,000 of income. On the basis of this information, the imputed interest rate was:

A) 2.5%.
B) 10.0%.
C) 12.5%.
D) 20.0%.
E) None of the answers is correct.

Question 61

Use the following information to answer the following Questions
Genesis Scents has two divisions: the Cologne Division and the Bottle Division. The Bottle Division produces containers that can be used by the Cologne Division. The Bottle Division's variable manufacturing cost is $2, shipping cost is $0.10, and the external sales price is $3. No shipping costs are incurred on sales to the Cologne Division, and the Cologne Division can purchase similar containers in the external market for $2.60.

-The Bottle Division has sufficient capacity to meet all external market demands in addition to meeting the demands of the Cologne Division. Using the general rule, the transfer price from the Bottle Division to the Cologne Division would be:

A) $2.00.
B) $2.10.
C) $2.60.
D) $2.90.
E) $3.00.

Question 62

Which of the following describes the goal that should be pursued when setting transfer prices?

A) Maximize profits of the buying division.
B) Maximize profits of the selling division.
C) Allow top management to become actively involved when calculating the proper dollar amounts.
D) Establish incentives for autonomous division managers to make decisions that are in the overall organization's best interests (i.e., goal congruence).
E) Minimize opportunity costs.

Question 63

Racine Corporation has excess capacity. If the firm desires to implement the general transfer-pricing rule, opportunity cost would be equal to:

A) zero.
B) the direct expenses incurred in producing the goods.
C) the total difference in the cost of production between two divisions.
D) the contribution margin forgone from the lost external sale.
E) the summation of variable cost plus fixed cost.

Question 64

Overton Company uses cost-based transfer pricing. Its Food Processing Division has a standard variable cost of $8.50 per case and allocated fixed overhead of $2.25. The Processing Division, which has excess capacity, sells its output to external customers for $12.00 per case.

- If Overton uses variable costs as its base, the transfer price charged to its Retail Division should be:

A) $14.25.
B) $12.00 plus a markup.
C) $10.75 plus a markup.
D) $8.50 plus a markup.
E) negotiated between the managers of the Processing and Retail Divisions.

Question 65

To partially eliminate the problems that are associated with the short-term focus of return on investment, residual income, and EVA, the performance of a division's major investments is commonly evaluated through:

A) postaudits.
B) sensitivity analysis.
C) performance operating plans.
D) horizontal analysis.
E) segmented reporting.

Question 66

Darrin's Auto Northern Division is currently purchasing a part from an outside supplier. The company's Southern Division, which has no excess capacity, makes and sells this part for external customers at a variable cost of $19 and a selling price of $31. If Southern begins sales to Northern, it (1) will use the general transfer-pricing rule and (2) will be able to reduce variable cost on internal transfers by $3. On the basis of this information, Southern would establish a transfer price of:

A) $16.
B) $19.
C) $28.
D) $31.
E) None of the answers is correct.

Question 67

Buzz's Florida Division is currently purchasing a part from an outside supplier. The company's Georgia Division, which has excess capacity, makes and sells this part for external customers at a variable cost of $22 and a selling price of $34. If Georgia begins sales to Florida, it (1) will use the general transfer-pricing rule and (2) will be able to reduce variable cost on internal transfers by $4. If sales to outsiders will not be affected, Georgia would establish a transfer price of:

A) $18.
B) $22.
C) $30.
D) $34.
E) None of the answers is correct.

Question 68

Use the following information to answer the following Questions
Genesis Scents has two divisions: the Cologne Division and the Bottle Division. The Bottle Division produces containers that can be used by the Cologne Division. The Bottle Division's variable manufacturing cost is $2, shipping cost is $0.10, and the external sales price is $3. No shipping costs are incurred on sales to the Cologne Division, and the Cologne Division can purchase similar containers in the external market for $2.60.

-Transfer prices can be based on:

A) variable cost.
B) full cost.
C) an external market price.
D) a negotiated settlement between the buying and selling divisions.
E) All of the answers are correct.

Question 69

Standard costs rather than actual costs should be used in transfer-pricing methods because:

A) financial accounting rules (GAAP) require the use of standard costs.
B) tax rules require the use of standard costs.
C) standard costs are more readily available than actual costs.
D) standard costs facilitate a professionally negotiated, amicable settlement between the buying and selling divisions.
E) inefficient producing divisions could pass on their inefficiencies to buying divisions in the transfer price.

Question 70

Consider the following statements about transfer pricing:
I) Income taxes and import duties are an important consideration when setting a transfer price for companies that pursue international commerce.
II) Transfer prices cannot be used by organizations in the service industry.
III) Transfer prices are totally cost-based in nature, not market-based.
Which of the above statements is (are) true?

A) I only.
B) II only.
C) I and II.
D) II and III.
E) I, II, and III.

Question 71

The Altamonte Division of Custom Industries is in need of a particular service. The service can be obtained from another division of Custom at "cost," with cost defined as the summation of variable cost ($9) and fixed cost ($3). Alternatively, Altamonte can secure the service from a source external to Custom for $10. Which of the following statements is true?

A) Altamonte should compare $10 versus $3 in deciding where to acquire the service.
B) Altamonte should compare $10 versus $9 in deciding where to acquire the service.
C) Altamonte should compare $10 versus $12 in deciding where to acquire the service.
D) From Custom's perspective, the proper decision is reached by comparing $10 versus $9.
E) Altamonte should both compare $10 versus $12 in deciding where to acquire the service and from Custom's perspective; the proper decision is reached by comparing $10 versus $9.

Question 72

Macon Corporation has no excess capacity. If the firm desires to implement the general transfer-pricing rule, opportunity cost would be equal to:

A) zero.
B) the direct expenses incurred in producing the goods.
C) the total difference in the cost of production between two divisions.
D) the contribution margin forgone from the lost external sale.
E) the summation of variable cost plus fixed cost.

Question 73

The amounts charged for goods and services exchanged between two divisions are known as:

A) opportunity costs.
B) transfer prices.
C) standard variable costs.
D) residual prices.
E) target prices.

Question 74

Grand's Auto Northern Division is currently purchasing a part from an outside supplier. The company's Southern Division, which has excess capacity, makes and sells this part for external customers at a variable cost of $19 and a selling price of $31. If Southern begins sales to Northern, it (1) will use the general transfer-pricing rule and (2) will be able to reduce variable cost on internal transfers by $3. On the basis of this information, Southern would establish a transfer price of:

A) $16.
B) $19.
C) $28.
D) $31.
E) None of the answers is correct.

Question 75

Use the following information to answer the following Questions
Genesis Scents has two divisions: the Cologne Division and the Bottle Division. The Bottle Division produces containers that can be used by the Cologne Division. The Bottle Division's variable manufacturing cost is $2, shipping cost is $0.10, and the external sales price is $3. No shipping costs are incurred on sales to the Cologne Division, and the Cologne Division can purchase similar containers in the external market for $2.60.

-Assume the Bottle Division has no excess capacity and could sell everything it produced externally. Using the general rule, the transfer price from the Bottle Division to the Cologne Division would be:

A) $2.00.
B) $2.10.
C) $2.60.
D) $2.90.
E) $3.00.

Question 76

Which of the following transfer-pricing methods can lead to dysfunctional decision-making behavior by managers?

A) Variable cost.
B) Full cost.
C) External market price.
D) A professionally negotiated, amicable settlement between the buying and selling divisions.
E) None of the answers is correct.

Question 77

The income calculation for a division manager's ROI should be based on:

A) divisional contribution margin.
B) profit margin controllable by the division manager.
C) profit margin traceable to the division.
D) divisional income before interest and taxes.
E) divisional net income.

Question 78

Use the following information to answer the following Questions
Genesis Scents has two divisions: the Cologne Division and the Bottle Division. The Bottle Division produces containers that can be used by the Cologne Division. The Bottle Division's variable manufacturing cost is $2, shipping cost is $0.10, and the external sales price is $3. No shipping costs are incurred on sales to the Cologne Division, and the Cologne Division can purchase similar containers in the external market for $2.60.

-The maximum amount the Cologne Division would be willing to pay for each bottle transferred would be:

A) $2.00.
B) $2.10.
C) $2.60.
D) $2.90.
E) $3.00.

Question 79

A general calculation method for transfer prices that achieves goal congruence begins with the additional outlay cost per unit incurred because goods are transformed and then

A) adds the opportunity cost per unit to the organization because of the transfer.
B) subtracts the opportunity cost per unit to the organization because of the transfer.
C) adds the sunk cost per unit to the organization because of the transfer.
D) subtracts the sunk cost per unit to the organization because of the transfer.
E) adds the sales revenue per unit to the organization because of the transfer.

Question 80

Clariton Corporation has two divisions, Kissimmee and Grant, and evaluates management on the basis of return on investment. Kissimmee currently makes a part that it sells to both Grant and outsiders. Selected data follow.

Kissimmee is seeking an increase in its selling price to $28 per unit because of rising costs. Grant can obtain comparable units from an outside supplier for $26; however, if Grant uses the supplier, Kissimmee will have idle capacity because of an inability to increase sales to outsiders. From the perspective of Clariton Corporation:

A) Kissimmee should continue to do business with Grant and charge $28 per unit.
B) Kissimmee should continue to do business with Grant and charge $25 per unit.
C) Kissimmee should continue to do business with Grant because Kissimmee's variable cost per unit is only $18.
D) Grant should do business with the outside supplier.
E) Grant should split its business between Kissimmee and the outside supplier.