Question 1

To evaluate overall aggregate performance,return on investment and residual income measures are more appropriate than return on sales.

Accepted Answer

Return on sales only measures profitability relative to revenue, whereas return on investment and residual income take into account the amount of capital invested in the business and the cost of capital, providing a more comprehensive evaluation of overall performance.

Question 2

The objective of maximising their return on investment may induce managers of highly profitable divisions to reject projects that from the viewpoint of the overall organisation should be accepted.

Accepted Answer

If managers are solely focused on maximising return on investment for their specific division, they may reject projects that would ultimately benefit the overall organisation. This can happen if the project doesn't align with their division's goals or if it doesn't provide a high enough return on investment for their division, even if it would benefit the organisation as a whole. Therefore, it is true that the objective of maximising return on investment may induce managers of highly profitable divisions to reject projects that should be accepted for the overall organisation.

Question 3

Answer the following questions using the information below:
The Bandage Medical Supply Company has two divisions that operate independently of one another.The financial data for the year 2017 reported the following results:
 $$\begin{array} { l r r } 
& \text { North } & \text { South } \
\text { Sales } & \$ 3000000 & \$ 2500000 \
\text { Operating profit } & 750000 & 550000 \
\text { Taxable income } & 650000 & 375000 \
\text { Investment } & 6000000 & 5000000
\end{array}$$ The company's desired rate of return is 10%.Profit is defined as operating profit.
-What are the respective residual incomes for the North and South Divisions?
A)$30 000 and $50 000
B)$50 000 and a negative $150 000
C)$150 000 and $50 000
D)$150 000 and $30 000

Accepted Answer

Residual income is calculated by subtracting the product of the cost of capital percentage and the divisional operating assets from the divisional operating income. Without specific numbers provided in the question, the correct answer cannot be directly calculated. However, the choice that lists both divisions with positive residual incomes suggests a scenario where both divisions are generating income above their cost of capital, which is a plausible outcome in a well-performing company.

Question 4

Residual income is a better evaluation method than return on investment because it has a lower required rate of return for the company projects than return on investment does.

Accepted Answer

Residual income and return on investment are both methods of evaluating the profitability of a company's projects. However, residual income takes into account the cost of capital and required rate of return, while return on investment does not. Therefore, residual income actually has a higher required rate of return for projects than return on investment does.

Question 5

Imputed costs are costs recognised in particular situations that are not usually incorporated in financial accounting records.

Accepted Answer

Imputed costs are costs that are not recorded in financial accounting but are recognised in certain situations, such as when assessing the true cost of a decision or project. Examples of imputed costs include opportunity cost, depreciation, and the cost of using capital or resources that are already owned.

Question 6

Boomerang Products has three divisions,which operate autonomously.Their results for 2017 were as follows:
 $$\begin{array} { | l | r | r | r | } 
\hline &  { \text { Standard } } & { \text { Deluxe } } & { \text { Supreme } } \
\hline \text { Sales } & \$ 30000000 & \$ 40000000 & \$ 50000000 \
\hline \text { Cost of goods sold } & 15000000 & 25000000 & 37000000 \
\hline \text { Operating profit } & 4500000 & 4750000 & 5000000 \
\hline \text { Investment base } & 18000000 & 18555000 & 18650000 \
\hline
\end{array}$$ 
The company's desired rate of return is 25%.
Required:
a.Calculate each division's ROI (round to three decimal places).
b.Calculate each division's residual income.
_____________________________________________________________________________________________
_____________________________________________________________________________________________

Accepted Answer

The answer of Boomerang Products has three divisions,which operate autonomously.Their...

Question 7

Answer the following questions using the information below:
The Bandage Medical Supply Company has two divisions that operate independently of one another.The financial data for the year 2017 reported the following results:
 $$\begin{array} { l r r } 
& \text { North } & \text { South } \
\text { Sales } & \$ 3000000 & \$ 2500000 \
\text { Operating profit } & 750000 & 550000 \
\text { Taxable income } & 650000 & 375000 \
\text { Investment } & 6000000 & 5000000
\end{array}$$ The company's desired rate of return is 10%.Profit is defined as operating profit.
-Which division has the best return on investment and which division has the best residual income figure,respectively?
A)North,North
B)South,South
C)South,North
D)North,South

Accepted Answer

The North division has the best return on investment (ROI) of 12.5% (750,000 / 6,000,000) and the best residual income figure of $150,000 (750,000 - 10% x 6,000,000).

Question 8

Illawarra Pizzas Corporation uses the investment centre concept for the pizza bars that it manages in the city.Illawarra has a 30% required rate of return on investment in order for a branch to be viable.Select operating data for three of its branches for 2017 are as follows:
 $$\begin{array} { | l | r | r | r | } 
\hline & \text { Acacia Street } & \text { Wattle Street } & \text { Gum Street } \
\hline \text { Revenue } & \$ 4250000 & \$ 3375000 & \$ 3750000 \
\hline \text { Operating assets } & 1750000 & 1750000 & 1250000 \
\hline \text { Net operating profit } & 480000 & 575000 & 455000 \
\hline
\end{array}$$ 
Required:
a.Compute the return on investment for each.
b.Which branch manager is doing best based only on ROI? Why?
c.Are any of the pizza bars in danger of being closed due to lack of performance?
d.What other factors should be included when evaluating the managers?
_____________________________________________________________________________________________
_____________________________________________________________________________________________

Accepted Answer

The answer of Illawarra Pizzas Corporation uses the investment centre...

Question 9

'Return on investment' is also called the 'imputed cost' of the investment.

Accepted Answer

The term 'imputed cost' refers to the opportunity cost of an investment, while 'return on investment' refers to the benefit or profit gained from that investment.

Question 10

Hargrave Products has three divisions,which operate autonomously.Their results for 2017 were as follows:
 $$\begin{array} { | l | r | r | r | } 
\hline & { \text { East } } &  { \text { West } } & \text { International } \
\hline \text { Sales } & \$ 30000000 & \$ 40000000 & \$ 50000000 \
\hline \text { Cost of goods sold } & 15000000 & 25000000 & 37000000 \
\hline \text { Operating profit } & 4500000 & 4750000 & 5000000 \
\hline \text { Investment base } & 30000000 & 30500000 & 31000000 \
\hline
\end{array}$$ 
The company's desired rate of return is 15%.
Required:
a.Compute each division's ROI (round to three decimal places).
b.Compute each division's residual income.
_____________________________________________________________________________________________
_____________________________________________________________________________________________

Accepted Answer

The answer of Hargrave Products has three divisions,which operate autonomously.Their...

Question 11

Goal congruence is more likely to be promoted by using return on investment rather than residual income as a measure of a subunit's managerial performance.

Accepted Answer

Residual income is a better measure of goal congruence as it motivates subunits to maximize their own wealth without sacrificing the overall performance of the company. Return on investment, on the other hand, may motivate subunits to focus on short-term profits rather than long-term value creation. Therefore, residual income promotes better goal congruence between subunits and the company as a whole.

Question 12

A problem with using residual income as a performance measure is that a corporation with a:
A)high investment turnover ratio always has a higher residual income than a corporation with a smaller investment turnover ratio.
B)larger dollar amount of assets is likely to have a higher residual income than a corporation with a smaller dollar amount of assets.
C)high return on sales always has a higher residual income than a corporation with a smaller return on sales.
D)None of these answers are correct.

Accepted Answer

Residual income is calculated by subtracting the cost of capital of a company's assets from its operating profit. Therefore, a company with a larger dollar amount of assets might have a higher residual income simply because it has more assets generating profit, not necessarily because it is more efficient or profitable in relative terms. This can make residual income a less effective measure for comparing performance across companies of different sizes.

Question 13

Costs recognised in particular situations but not incorporated in financial accounting records are:
A)imputed costs.
B)cash accounting costs.
C)opportunity costs.
D)None of these answers are correct.

Accepted Answer

Imputed costs are costs that are not actually paid out in cash, but are recognized as if they had been. These costs are often used to account for the use of company resources or the cost of forgoing other potential opportunities. They are not typically recorded in financial accounting records.

Question 14

John's Mobile Phone Company uses ROI to measure divisional performance.Annual ROI calculations for each division have traditionally employed the ending amount of invested capital along with annual operating profit and net revenue.The DuPont method is generally used.The company's Phone Accessories Division had the following results for the last two years:
2016 ROI = ($2 000 000/$20 000 000)× ($20 000 000/$10 000 000)= 0.20
2017 ROI = ($2 400 000/$25 000 000)× ($25 000 000/$15 000 000)= 0.16
Corporate management was disappointed in the performance of the division for 2017,since it had made an additional investment in the division that was budgeted for a 23% ROI.
Required:
a.Discuss some factors that may have contributed to the decrease in ROI for 2017.
b.Would there have been any substantial difference if average capital had been used?
_____________________________________________________________________________________________
_____________________________________________________________________________________________

Accepted Answer

The answer of John's Mobile Phone Company uses ROI to...

Question 15

Frenchs Forest Publishing Company has three divisions that operate autonomously.Their results for 2017 are as follows:
 $$\begin{array} { | l | r | r | r | } 
\hline & { \text { Academic } } &  { \text { Fiction } } & { \text { Non-fiction } } \
\hline \text { Sales } & \$ 15000000 & \$ 17000000 & \$ 20000000 \
\hline \text { Contribution margin } & 1440000 & 1700000 & 3500000 \
\hline \text { Operating profit } & 1500000 & 1200000 & 2120000 \
\hline \text { Investment base } & 7000000 & 5000000 & 14000000 \
\hline
\end{array}$$ 
The company's desired rate of return is 20%.
Required:
a.Calculate each division's ROI.
b.Calculate each division's residual income.
c.Rank each division by both ROI and residual income.
d.Which division had the best performance in 2017? Why?
_____________________________________________________________________________________________
_____________________________________________________________________________________________

Accepted Answer

The answer of Frenchs Forest Publishing Company has three divisions...

Question 16

Using residual income as a measure of performance rather than return on investment promotes goal congruence because residual income:
A)places importance on the reduction of underperforming assets.
B)concentrates on maximising an absolute amount of dollars.
C)calculates a percentage return rather than an absolute return.
D)concentrates on maximising the return on sales.

Accepted Answer

Residual income focuses on maximizing an absolute dollar amount rather than a percentage return, aligning the interests of managers with those of the company as a whole by encouraging the pursuit of projects that generate more income over the cost of capital, regardless of the impact on the percentage return metrics.

Question 17

Batman Abstract Company has three divisions that operate autonomously.Their results for 2017 are as follows:
 $$\begin{array} { | l | r | r | r | } 
\hline &{ \text { Riddler } } &  { \text { Joker } } & { \text { Penguin } } \
\hline \text { Sales } & \$ 5000000 & \$ 7000000 & \$ 10000000 \
\hline \text { Contribution margin } & 1440000 & 1700000 & 3500000 \
\hline \text { Operating profit } & 1000000 & 1750000 & 2520000 \
\hline \text { Investment base } & 9000000 & 10000000 & 14000000 \
\hline
\end{array}$$ 
The company's desired rate of return is 20%.
Required:
a.Calculate each division's ROI.
b.Calculate each division's residual income.
c.Rank each division by both ROI and residual income.
d.Which division had the best performance in 2017? Why?
_____________________________________________________________________________________________
_____________________________________________________________________________________________

Accepted Answer

The answer of Batman Abstract Company has three divisions that...

Question 18

A company which favours the residual income approach to measure performance wants managers to:
A)concentrate on maximising a percentage return.
B)maximise return on sales.
C)concentrate on maximising an absolute amount of dollars.
D)maximise the investment turnover ratio.

Accepted Answer

The residual income approach measures the excess income generated by a business after accounting for the cost of the capital used to generate that income. Therefore, the focus is on maximizing the absolute amount of dollars, which represents the residual income. Maximizing a percentage return or return on sales would not necessarily lead to the highest residual income. Maximizing the investment turnover ratio would focus on generating more revenue but may not take into account the cost of capital and could potentially decrease residual income.

Question 19

Provide the missing data for the following situations:
 $$\begin{array} { | l | r | r | r | } 
\hline & \text { River Division } & \text { Stream Division } & \text { Creek Division } \
\hline \text { Sales } & \$ ? & \$ 5000000 & \$ ? \
\hline \text { Net operating profit } & \$ 100000 & \$ 200000 & \$ 144000 \
\hline \text { Operating assets } & \$ ? & \$ ? & \$ 800000 \
\hline \text { Return on investment } & 0.16 & 0.10 & ? \
\hline \text { Return on sales } & 0.04 & ? & 0.12 \
\hline \text { Investment turnover } & ? & ? & 1.5 \
\hline
\end{array}$$

Accepted Answer

The answer of Provide the missing data for the following...

Question 20

Consolidated Supply Corporation uses the investment centre concept for the service stations that it manages in the city.Consolidated has a 15% required rate of return on investment in order for a branch station to be viable.Select operating data for three of its stations for 2017 are as follows:
 $$\begin{array} { | l | r | r | r | } 
\hline &{ \text { Pine Street } } & \text { Oak Street } &  { \text { GumStreet } } \
\hline \text { Revenue } & \$ 8500000 & \$ 6750000 & \$ 7500000 \
\hline \text { Operating assets } & 3500000 & 3500000 & 2500000 \
\hline \text { Net operating profit } & 480000 & 575000 & 455000 \
\hline
\end{array}$$ 
Required:
a.Compute the return on investment for each station.
b.Which service station manager is doing best based only on ROI? Why?
c.Are any of the service stations in danger of being closed due to lack of performance?
d.What other factors should be included when evaluating the managers?

Accepted Answer

The answer of Consolidated Supply Corporation uses the investment centre...

Quiz 20: Performance Measurement, Compensation and Multinational Considerations

To evaluate overall aggregate performance,return on investment and residual income measures are more appropriate than return on sales.

The objective of maximising their return on investment may induce managers of highly profitable divisions to reject projects that from the viewpoint of the overall organisation should be accepted.

Residual income is a better evaluation method than return on investment because it has a lower required rate of return for the company projects than return on investment does.

Imputed costs are costs recognised in particular situations that are not usually incorporated in financial accounting records.

'Return on investment' is also called the 'imputed cost' of the investment.

Goal congruence is more likely to be promoted by using return on investment rather than residual income as a measure of a subunit's managerial performance.

A problem with using residual income as a performance measure is that a corporation with a:

Costs recognised in particular situations but not incorporated in financial accounting records are:

Using residual income as a measure of performance rather than return on investment promotes goal congruence because residual income:

A company which favours the residual income approach to measure performance wants managers to: