Exam 14: Business Unit Performance Measurement

Roxie,Inc.has used a decentralized form of organizational structure for the past five years.The controller,Ms.Hamburg,has noticed that some of the divisions are still using fixed assets that are fully depreciated and that there has been little acquisition activity in these divisions.Coupled with this are very high ROIs,especially when compared to the other divisions that seem to have a regular program of disposition and replacement of fixed assets.She takes her concerns and observations to the Financial Vice President who says he will review her findings and look into the problem.Required: 1)What are the potential negative effects of decentralization? 2)Specifically discuss the issues involved in suboptimization.

The Calculating Fashion Company has two operating divisions: North and South.The following information was collected from its financial statements. North South Operating inc ome \ 15,375 \ 9,160 Sales 90,100 128,445 Average operating assets 47,620 37,690 Required: Compute the following ratios for each division: a.Profit margin b.Asset turnover c.Return on investment (ROI)

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

The Jones Company purchased assets costing $200,000 which will be depreciated over 5-years using straight-line depreciation and no salvage value.The Jones also purchased land and other assets,which are not depreciable at a cost of $200,000.It is estimated that in 5-years,the value of these assets will be unchanged.Assume that annual cash profits are $80,000 and,for return on investment (ROI)calculations,the company uses end-of-year asset values.What is the ROI for each year using net book value? Year 1 Year 2 Year 3 Year 4 A. 11.1\% 12.5\% 14.3\% 16.7\% B. 10.0\% 10.0\% 10.0\% 10.0\% C. 10.0\% 8.9\% 7.3\% 6.5\% D. 11.1\% 11.5\% 12.5\% 12.3\%

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

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

Bleu Stone is a division of a major corporation.The following data are for the latest year of operations: Sales \ 33,040,000 Net operating income \ 1,453,760 Average operating assets \ 8,000,000 The company's minimum required rate of return 18\% Required: a. What is the division's margin? b. What is the division's turnover? c. What is the division's return on investment (ROI)? d. What is the division's residual income?

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.

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

Mallory,Inc.has the following data available for two of its divisions for last year: Asian Division European Dirision Sales \ 460,000 \ 900,000 Contribution Margin 184,000 470,000 Operating income 92,000 90,000 Average operating assets 368,000 750,000 Weighted average cost of 14\% 14\% capital The imputed interest for Mallory,Inc.is 24%.The tax rate for Mallory,Inc.is 18%.Required: (1)Compute the following for each division: (a)Sales margin.(b)Capital turnover.(c)ROI.(d)Residual income.(e)EVA (assume there are no current liabilities).(2)Briefly discuss which division appears most successful and why?

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.

Explain the difference between the gross margin ratio,the operating margin ratio,and the profit margin ratio.

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

The Jones Company purchased assets costing $200,000 which will be depreciated over 5-years using straight-line depreciation and no salvage value.The Jones also purchased land and other assets,which are not depreciable at a cost of $200,000.It is estimated that in 5-years,the value of these assets will be unchanged.Assume that annual cash profits are $80,000 and,for return on investment (ROI)calculations,the company uses end-of-year asset values.What is the ROI for each year using gross book value? Year 1 Year 2 Year 3 Year 4 A. 10.0\% 9.5\% 8.0\% 7.9\% B. 10.0\% 10.0\% 10.0\% 10.0\% C. 12.5\% 11.0\% 12.0\% 15.0\% D. 10.0\% 12.5\% 14.0\% 17.0\%

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)

What is the problem with choosing a beginning,ending or average balance when measuring the investment base for performance evaluation?

Financial data for Windsor,Inc.for last year appear below: The company paid dividends of $104,000 last year.The "Investment in Pine Company" on the statement of financial position represents an investment in the stock of another company.Required: a.Compute the company's margin,turnover,and return on investment for last year.b.The Board of Directors of Windsor,Inc.has set a minimum required return of 25%.What was the company's residual income last year?

Garage 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?

Decentralization is lauded as important to good management.But it isnot without its problems.Required: Identify the advantages and disadvantages of decentralization? How do ROI,Residual Income,and EVA affect these issues?