Exam 19: Strategic Performance Measurement: Investment Centers and Transfer Pricing

Selected data from Chering Division's accounting records revealed the following: Sales \ 825,000 Average investment \ 440,000 Net operating income \ 66,000 Minimum rate of return (divisional cost of capital) 14\% If the minimum rate of return (i.e., cost of capital) was 13%, Chering Division's residual income (RI) would calculate to be:

Which of the following is true about return on investment (ROI)?

Transfer prices based on actual costs of the selling division as opposed to standard costs incurred by that division:

EVA® (economic value added):

All of the following are true of market-based transfer prices except:

Listed below is selected financial information for the Western Division of the Henzel Company for last year: Account Amount (thousands) Average working capital \ 625 General and administrative expenses 75 Net sales 4,000 Average plant and equipment 1,775 Cost of goods sold 3,525 If Henzel treats the Western Division as an investment center for performance evaluation purposes, what is the before-tax return on investment (ROI) for last year? (Round your answer to two decimal places.)

Assume the following facts regarding a product that Division P can sell internally (to Division B) or externally on the open market. Incremental (i.e., out-of-pocket) cost to Division P for each unit produced = $12. External purchase price, to be paid by Division B = $13.50. Total units needed (annually) by Division B = 1,000. Required: 1. Assume that there are no alternative uses for Division P's facilities. Determine whether the company as a whole will benefit if Division B purchases the product externally. At what amount should the transfer price be set such that each divisional manager, acting in the best interest of his or her own division, take actions that are in the best interest of the company as a whole? 2. Assume that Division P's facilities would not otherwise be idle if it didn't produce the product for Division B. By not producing the product for Division B, the freed-up facilities would be used to generate a net cash benefit of $1,800. Should Division B purchase from suppliers? (Show calculations.) 3. Assume that for the foreseeable future there are no alternative uses for Division P's facilities, and that the outside supplier's cost to Division B drops by $2. Under this circumstance, should Division B purchase externally? At what amount should the transfer price be set such that each divisional manager, acting in the best interest of his or her division, would take actions that are in the best interest of the company as a whole?

The following results pertain to an investment center. Sales \ 1,500,000 Variable costs 800,000 Traceable fixed costs 100,000 Average investment 1,000,000 Divisional cost of capital (discount rate) 10\% How much is the residual income (RI) for this investment center?

A dollar amount equal to the operating income of a division less a charge for the level of investment in the division is called:

A key standard in international transfer pricing is:

This question deals with summary financial performance indicators for investment centers. Required: 1. Discuss the similarities among ROI, residual income (RI), and EVA®. 2. In what sense is EVA® similar to and in what sense is it distinct from residual income (RI)? 3. Present the equation for calculating EVA® and provide a brief discussion of the elements that go into the calculation of EVA®. 4. What are the two approaches that can be used to estimate the two major components of EVA®? Which of these two approaches is superior?

The greatest advantage of using a negotiated transfer price is:

Which one of the following establishes an "arm's-length price" by using the sales prices of similar products made by unrelated firms?

Consider the following data for three divisions of a company, X, Y, and Z: Divisional: X Y Z Sales \ 2,200,000 \ 1,100,000 \ 5,800,000 Operating income 330,000 143,000 580,000 Investment (assets) 750,000 572,000 2,900,000 Required: Calculate return on investment (ROI), return on sales (ROS), and asset turnover (AT) for each division.Round your answers to two decimal places where appropriate.

The major criticism of using return on investment (ROI) for evaluating the financial performance of business units considered investment centers is that ROI:

The primary limitation of using Economic Value Added (EVA®) to evaluate the financial performance of investment centers is:

Edwards Inc. manufactures electronics. It consists of several divisions classified as investment centers for performance evaluation purposes. Division A desires to purchase materials from Division B at a price of $85 per unit. Division B can produce 25,000 units at full capacity, and is currently operating at 90% capacity with a variable cost of $80 per unit. Division B currently sells only to outside customers who pay $115 per unit. Division A pays an outside company $110 per unit. If purchased from Division B, B's variable costs per unit would be $10 less because the division would save on marketing expenses for these internal transfers. Division A requires 10,000 units. Required: 1. How would Division B selling to Division A affect Division A's purchasing costs? 2. How would intercompany sales affect Division B? 3. What solution would be best for Edwards Inc., assuming Division B has the ability to operate at full capacity?

The difference between the historical cost and the net book value (NBV) of a plant asset is the:

What special problems and opportunities arise in setting transfer prices in an international setting (i.e., for transfers between subunits that operate in different countries)? Hint: In terms of special problems, make sure you reference OECD requirements and practical implementation alternatives for general OECD requirements.)

Which of the following specifications for calculating EVA® is correct?