Quiz 12: Performance Evaluation and Decentralization

Discuss the differences between centralized and decentralized decision making.

practice of delegating authority to division-level managers by top management is A) decentralization. B) good business practice. C) centralization. D) autonomy. E) never done in business today.

is decentralization?

Which of the following is not a reason for decentralizing? A) Training and motivating managers B) Unmasking inefficiencies in subdivisions of an overall profitable company C) Allowing top management to focus on strategic decision making D) Allowing top management to make all key operating decisions throughout the company E) All of the above are reasons for decentralizing.

Explain why firms choose to decentralize.

responsibility center in which a manager is responsible only for costs is a(n) A) investment center. B) revenue center. C) profit center. D) cost center.

are margin and turnover? Explain how these concepts can improve the evaluation of an investment center.

responsibility center in which a manager is responsible for revenues, costs, and investments is a(n) A) investment center. B) revenue center. C) profit center. D) cost center.

are the three benefits of ROI? Explain how each benefit can lead to improved profitability.

sales and average operating assets for Year 2 are identical to their values in Year 1, yet operating income is higher, Year 2 return on investment (compared with Year 1 ROI) will A) decrease. B) increase. C) stay the same. D) The direction of change in ROI cannot be determined by this information.

is residual income? What is EVA? How does EVA differ from the general definition of residual income?

sales and average operating assets for Year 2 are identical to their values in Year 1, yet operating income is higher, Year 2 turnover (compared with Year 1 turnover) will A) decrease. B) increase. C) stay the same. D) The direction of change in turnover cannot be determined by this information.

residual income or EVA ever be negative? What is the meaning of negative residual income or EVA?

key difference between residual income and EVA is that EVA A) uses the actual cost of capital for the company rather than a minimum required cost of capital. B) uses the minimum required cost of capital for a company rather than the actual percentage cost of capital. C) is a ratio rather than an absolute dollar amount. D) cannot be negative. E) There is no difference between residual income and EVA.

is a transfer price?

ROI for a division is 15% and the company's minimum required cost of capital is 18%, then A) residual income for the division is negative. B) residual income for the division takes on a value between zero and positive one. C) residual income cannot be computed. D) EVA must be negative. E) residual income is positive.

Briefly explain three common transfer pricing policies used by organizations.

Division A manufactures an aircraft engine component with unit variable product cost of $38 and market price of $50. Division A incurs shipping costs of $3 per unit for sales to outside parties only. Division B uses this component in the manufacture of its own engine production activities. Top management allows negotiated transfer pricing. Refer to the information above. If Division A is operating at full capacity, the maximum transfer price (the ceiling of the bargaining range) is A) $38. B) $50. C) $44. D) $47. E) There is no bargaining range.

Appendix 12A ) What is the Balanced Scorecard?

Division A manufactures an aircraft engine component with unit variable product cost of $38 and market price of $50. Division A incurs shipping costs of $3 per unit for sales to outside parties only. Division B uses this component in the manufacture of its own engine production activities. Top management allows negotiated transfer pricing. Refer to the information above. If Division A is operating at less than full capacity, the minimum transfer price (the floor of the bargaining range) is A) $38. B) $50. C) $44. D) $47. E) There is no bargaining range.

Appendix 12A ) Describe the four perspectives of the Balanced Scorecard.

Appendix 12A ) Which of the following is a perspective of the Balanced Scorecard? A) Learning and growth (infrastructure) B) Internal business process C) Customer D) Financial E) All of these are perspectives of the Balanced Scorecard.

Appendix 12A ) The length of time it takes to produce a unit of output from the time raw materials are received until the good is delivered to finished goods inventory is called A) velocity. B) cycle time. C) manufacturing cycle efficiency. D) theoretical cycle time. E) theoretical MCE.

Calculating Average Operating Assets, Margin, Turnover, and Return on Investment East Mullett Manufacturing earned operating income last year as shown in the following income statement: At the beginning of the year, the value of operating assets was $1,600,000. At the end of the year, the value of operating assets was $1,400,000. Refer to the information for East Mullett Manufacturing above. Round answers to two decimal places.

Calculating Residual Income East Mullett Manufacturing earned operating income last year as shown in the following income statement: At the beginning of the year, the value of operating assets was $1,600,000. At the end of the year, the value of operating assets was $1,400,000. Refer to the information for East Mullett Manufacturing above. East Mullett requires a minimum rate of return of 5%.

Calculating Economic Value Added East Mullett Manufacturing earned operating income last year as shown in the following income statement: At the beginning of the year, the value of operating assets was $1,600,000. At the end of the year, the value of operating assets was $1,400,000. Refer to the information for East Mullett Manufacturing above. Total capital employed equaled $1,200,000. East Mullett's actual cost of capital is 4%.

Calculating Transfer Price Burt Inc. has a number of divisions, including the Indian Division, a producer of liquid pumps, and Maple Division, a manufacturer of boat engines. Indian Division produces the h20-model pump that can be used by Maple Division in the production of motors that regulate the raising and lowering of the boat engine's stern drive unit. The market price of the h20-model is $720, and the full cost of the h20-model is $540.

Appendix 12A ) Calculating Cycle Time and Velocity Indy Company has the following data for one of its manufacturing plants: Maximum units produced in a quarter (3-month period): 250,000 units Actual units produced in a quarter (3-month period): 200,000 units Productive hours in one quarter: 25,000 hours Refer to the information for Indy Company above.

Appendix 12A ) Calculating Manufacturing Cycle Efficiency Indy Company has the following data for one of its manufacturing plants: Maximum units produced in a quarter (3-month period): 250,000 units Actual units produced in a quarter (3-month period): 200,000 units Productive hours in one quarter: 25,000 hours Refer to the information for Indy Company above. The actual cycle time for Indy Company is 7.5 minutes and the theoretical cycle time is 6 minutes.

Types of Responsibility Centers Consider each of the following independent scenarios: a. Terrin Belson, plant manager for the laser printer factory of Compugear Inc., brushed his hair back and sighed. December had been a bad month. Two machines had broken down, and some factory production workers (all on salary) were idled for part of the month. Materials prices increased, and insurance premiums on the factory increased. No way out of it; costs were going up. He hoped that the marketing vice president would be able to push through some price increases, but that really wasn't his department. b. Joanna Pauly was delighted to see that her ROI figures had increased for the third straight year. She was sure that her campaign to lower costs and use machinery more efficiently (enabling her factories to sell several older machines) was the reason why. Joanna planned to take full credit for the improvements at her semiannual performance review. c. Gil Rodriguez, sales manager for ComputerWorks, was not pleased with a memo from headquarters detailing the recent cost increases for the laser printer line. Headquarters suggested raising prices. ''Great,'' thought Gil, ''an increase in price will kill sales and revenue will go down. Why can't the plant shape up and cut costs like every other company in America is doing? Why turn this into my problem?'' d. Susan Whitehorse looked at the quarterly profit and loss statement with disgust. Revenue was down, and cost was up-what a combination! Then she had an idea. If she cut back on maintenance of equipment and let a product engineer go, expenses would decrease-perhaps enough to reverse the trend in income. e. Shonna Lowry had just been hired to improve the fortunes of the Southern Division of ABC Inc. She met with top staff and hammered out a 3-year plan to improve the situation. A centerpiece of the plan is the retiring of obsolete equipment and the purchasing of stateof- the-art, computer-assisted machinery. The new machinery would take time for the workers to learn to use, but once that was done, waste would be virtually eliminated.

Margin, Turnover, Return on Investment Pelak Company had sales of $25,000,000, expenses of $17,500,000, and average operating assets of $10,000,000.

Margin, Turnover, Return on Investment, Average Operating Assets Elway Company provided the following income statement for the last year: At the beginning of last year, Elway had $28,300,000 in operating assets. At the end of the year, Elway had $23,700,000 in operating assets.

Return on Investment, Margin, Turnover Data follow for the Construction Division of D. Jack Inc.: ( Note: Round all answers to two decimal places.)

Residual Income The Tuxedo Division of Shamus O'Toole Company had operating income last year of $152,250,000 and average operating assets of $2,175,000,000. O'Toole's minimum acceptable rate of return is 8%. ( Note: Round all answers to two decimal places.)

Economic Value Added Falconer Company had net (after-tax) income last year of $12,375,400 and total capital employed of $111,754,000. Falconer's actual cost of capital was 9%.

Economic Value Added Washington Company has two divisions: the Adams Division and the Jefferson Division. The following information pertains to last year's results: Washington's actual cost of capital was 12%. Refer to the information for Washington Company above.

Residual Income Washington Company has two divisions: the Adams Division and the Jefferson Division. The following information pertains to last year's results: Washington's actual cost of capital was 12%. Refer to the information for Washington Company above. In addition, Washington Company's top management has set a minimum acceptable rate of return equal to 8%.

Transfer Pricing Aulman Inc. has a number of divisions, including a Furniture Division and a Motel Division. The Motel Division owns and operates a line of budget motels located along major highways. Each year, the Motel Division purchases furniture for the motel rooms. Currently, it purchases a basic dresser from an outside supplier for $40. The manager of the Furniture Division has approached the manager of the Motel Division about selling dressers to the Motel Division. The full product cost of a dresser is $29. The Furniture Division can sell all of the dressers it makes to outside companies for $40. The Motel Division needs 10,000 dressers per year; the Furniture Division can make up to 50,000 dressers per year. Refer to the information for Aulman Inc. above.

Transfer Pricing Aulman Inc. has a number of divisions, including a Furniture Division and a Motel Division. The Motel Division owns and operates a line of budget motels located along major highways. Each year, the Motel Division purchases furniture for the motel rooms. Currently, it purchases a basic dresser from an outside supplier for $40. The manager of the Furniture Division has approached the manager of the Motel Division about selling dressers to the Motel Division. The full product cost of a dresser is $29. The Furniture Division can sell all of the dressers it makes to outside companies for $40. The Motel Division needs 10,000 dressers per year; the Furniture Division can make up to 50,000 dressers per year. Refer to the information for Aulman Inc. above. Also, assume that the company policy is that all transfer prices are negotiated by the divisions involved.

Transfer Pricing Aulman Inc. has a number of divisions, including a Furniture Division and a Motel Division. The Motel Division owns and operates a line of budget motels located along major highways. Each year, the Motel Division purchases furniture for the motel rooms. Currently, it purchases a basic dresser from an outside supplier for $40. The manager of the Furniture Division has approached the manager of the Motel Division about selling dressers to the Motel Division. The full product cost of a dresser is $29. The Furniture Division can sell all of the dressers it makes to outside companies for $40. The Motel Division needs 10,000 dressers per year; the Furniture Division can make up to 50,000 dressers per year. Refer to the information for Aulman Inc. above. Also, although the Furniture Division has been operating at capacity (50,000 dressers per year), it expects to produce and sell only 40,000 dressers for $40 each next year. The Furniture Division incurs variable costs of $14 per dresser. The company policy is that all transfer prices are negotiated by the divisions involved.

Appendix 12A ) Cycle Time and Velocity Prakesh Company has the following data for one of its manufacturing cells: Maximum units produced in a month: 50,000 units Actual units produced in a month: 40,000 units Hours of production labor in one month: 10,000 hours

Appendix 12A ) Cycle Time and Velocity Lasker Company divided its tool production factory into manufacturing cells. Each cell produces one product. The cordless drill cell had the following data for last quarter: Maximum units produced in a quarter: 90,000 units Actual units produced in a quarter: 75,000 units Hours of cell production labor in a quarter: 30,000 hours

Appendix 12A ) Manufacturing Cycle Efficiency Ventris Company found that one of its manufacturing cells had actual cycle time of 15 minutes per unit. The theoretical cycle time for this cell was 9 minutes per unit.

Appendix 12A ) Manufacturing Cycle Efficiency Kurena Company provided the following information on one of its factories: Maximum units produced in a quarter: 180,000 units Actual units produced in a quarter: 112,500 units Hours of cell production labor in a quarter: 30,000 hours Theoretical cycle time: 10 minutes per unit Actual cycle time: 16 minutes per unit

Return on Investment and Investment Decisions Leslie Blandings, division manager of Audiotech Inc., was debating the merits of a new product-a weather radio that would put out a warning if the county in which the listener lived were under a severe thunderstorm or tornado alert. The budgeted income of the division was $725,000 with operating assets of $3,625,000. The proposed investment would add income of $640,000 and would require an additional investment in equipment of $4,000,000. The minimum required return on investment for the company is 12%. Round all numbers to two decimal places.

Return on Investment, Margin, Turnover Ready Electronics is facing stiff competition from imported goods. Its operating income margin has been declining steadily for the past several years. The company has been forced to lower prices so that it can maintain its market share. The operating results for the past 3 years are as follows: For the coming year, Ready's president plans to install a JIT purchasing and manufacturing system. She estimates that inventories will be reduced by 70% during the first year of operations, producing a 20% reduction in the average operating assets of the company, which would remain unchanged without the JIT system. She also estimates that sales and operating income will be restored to Year 1 levels because of simultaneous reductions in operating expenses and selling prices. Lower selling prices will allow Ready to expand its market share. ( Note: Round all numbers to two decimal places.)

Return on Investment for Multiple Investments, Residual Income The manager of a division that produces add-on products for the automobile industry has just been presented the opportunity to invest in two independent projects. The first is an air conditioner for the back seats of vans and minivans. The second is a turbocharger. Without the investments, the division will have average assets for the coming year of $28.9 million and expected operating income of $4.335 million. The outlay required for each investment and the expected operating incomes are as follows: ( Note: Round all numbers to two decimal places.)

Return on Investment and Economic Value Added Calculations with Varying Assumptions Knitpix Products is a division of Parker Textiles Inc. During the coming year, it expects to earn income of $310,000 based on sales of $3.45 million. Without any new investments, the division will have average operating assets of $3 million. The division is considering a capital investment project-adding knitting machines to produce gaiters-that requires an additional investment of $600,000 and increases net income by $57,500 (sales would increase by $575,000). If made, the investment would increase beginning operating assets by $600,000 and ending operating assets by $400,000. Assume that the actual cost of capital for the company is 7%. ( Note: Round all answers to four decimal places.)

Transfer Pricing GreenWorld Inc. is a nursery products firm. It has three divisions that grow and sell plants: the Western Division, the Southern Division, and the Canadian Division. Recently, the Southern Division of GreenWorld acquired a plastics factory that manufactures green plastic pots. These pots can be sold both externally and internally. Company policy permits each manager to decide whether to buy or sell internally. Each divisional manager is evaluated on the basis of ROI and EVA. The Western Division had bought its plastic pots in lots of 100 from a variety of vendors. The average price paid was $75 per box of 100 pots. However, the acquisition made Rosario Sanchez-Ruiz, manager of the Western Division, wonder whether or not a more favorable price could be arranged. She decided to approach Lorne Matthews, manager of the Southern Division, to see if he wanted to offer a better price for an internal transfer. She suggested a transfer of 3,500 boxes at $70 per box. Lorne gathered the following information regarding the cost of a box of 100 pots:

Setting Transfer Prices-Market Price versus Full Cost Lansing Electronics Inc. manufactures a variety of printers, scanners, and fax machines in its two divisions: the PSF Division and the Components Division. The Components Division produces electronic components that can be used by the PSF Division. All the components this division produces can be sold to outside customers. However, from the beginning, nearly 90% of its output has been used internally. The current policy requires that all internal transfers of components be transferred at full cost. Recently, Cam DeVonn, the chief executive officer of Lansing Electronics, decided to investigate the transfer pricing policy. He was concerned that the current method of pricing internal transfers might force decisions by divisional managers that would be suboptimal for the firm. As part of his inquiry, he gathered some information concerning Component Y34, which is used by the PSF Division in its production of a basic scanner, Model SC67. The PSF Division sells 40,000 units of Model SC67 each year at a unit price of $42. Given current market conditions, this is the maximum price that the division can charge for Model SC67. The cost of manufacturing the scanner follows: The scanner is produced efficiently, and no further reduction in manufacturing costs is possible. The manager of the Components Division indicated that she could sell 40,000 units (the division's capacity for this part) of Component Y34 to outside buyers at $12 per unit. The PSF Division could also buy the part for $12 from external suppliers. She supplied the following details on the manufacturing cost of the component:

Cost-Plus Pricing and Negotiation Techno via Inc. has two divisions: Auxiliary Components and Audio Systems. Divisional managers are encouraged to maximize ROI and EVA. Managers are essentially free to determine whether goods will be transferred internally and what will be the internal transfer prices. Headquarters has directed that all internal prices be expressed on a full cost-plus basis. The markup in the full cost pricing arrangement, however, is left to the discretion of the divisional managers. Recently, the two divisional managers met to discuss a pricing agreement for a subwoofer that would be sold with a personal computer system. Production of the subwoofers is at capacity. Subwoofers can be sold for $31 to outside customers. The Audio Systems Division can also buy the subwoofer from external sources for the same price; however, the manager of this division is hoping to obtain a price concession by buying internally. The full cost of manufacturing the subwoofer is $20. If the manager of the Auxiliary Components Division sells the subwoofer internally, $5 of selling and distribution costs can be avoided. The volume of business would be 250,000 units per year, which is well within the capacity of the producing division. After some discussion, the two managers agreed on a full cost-plus pricing scheme that would be reviewed annually. Any increase in the outside selling price would be added to the transfer price by simply increasing the markup by an appropriate amount. Any major changes in the factors that led to the agreement could initiate a new round of negotiation. Otherwise, the full cost-plus arrangement would continue in force for subsequent years.

Appendix 12A ) Cycle Time, Velocity, Conversion Cost The theoretical cycle time for a product is 30 minutes per unit. The budgeted conversion costs for the manufacturing cell are $2,700,000 per year. The total labor minutes available are 600,000. During the year, the cell was able to produce 1.5 units of the product per hour. Suppose also that production incentives exist to minimize unit product costs.

Appendix 12A ) Balanced Scorecard The following list gives a number of measures associated with the Balanced Scorecard: a. number of new customers b. percentage of customer complaints resolved with one contact c. unit product cost d. cost per distribution channel e. suggestions per employee f. warranty repair costs g. consumer satisfaction (from surveys) h. cycle time for solving a customer problem i. strategic job coverage ratio j. on-time delivery percentage k. percentage of revenues from new products

Appendix 12A ) Cycle Time and Velocity, Manufacturing Cycle Efficiency A company like Kicker performs warranty repair work on speakers in a manufacturing cell. The typical warranty repair involves taking the defective speaker apart, testing the components, and replacing the defective components. The maximum capacity of the cell is 1,000 repairs per month. There are 500 production hours available per month.

Return on Investment Ethical Considerations Jason Kemp was torn between conflicting emotions. On the one hand, things were going so well. He had just completed six months as the assistant financial manager in the Electronics Division of Med-Products Inc. The pay was good, he enjoyed his coworkers, and he felt that he was part of a team that was making a difference in American health care. On the other hand, his latest assignment was causing some sleepless nights. Mel Cravens, his boss, had asked him to ''refine'' the figures on the division's latest project-a portable imaging device code-named ZM. The original estimates called for investment of $15.6 million and projected annual income of $1.87 million. Med-Products required an ROI of at least 15% for new project approval. So far, ZM's rate of return was nowhere near that hurdle rate. Mel encouraged him to show increased sales and decreased expenses in order to get the projected income above $2.34 million. Jason asked for a meeting with Mel to voice his concerns. Jason: Mel, I've gone over the figures for the new project and can't find any way to get the income above $1.9 million. The salespeople have given me the most likely revenue figures, and production feels that the expense figures are solid. Mel: Jason, those figures are just projections. Sales doesn't really know what the revenue will be. In fact, when I talked with Sue Harris, our sales vice president, she said that sales could range from $1.5 million to $2.5 million. Use the higher figure. I'm sure this product will justify our confidence in it! Jason: I know the range of sales was that broad, but Sue felt the $2.5 million estimate was pretty unlikely. She thought that during the first 5 years or so that ZM sales would stay in the lower end of the range. Mel: Again, Sue doesn't know for sure. She's just estimating. Let's go with the higher estimate. We really need this product to expand our line and to give our division a chance to qualify for sales-based bonuses. If ZM sells at all, our revenue will go up, and we'll all share in the bonus pool! Jason: I don't know, Mel. I feel pretty bad signing off on ROI projections that I have so little confidence in. Mel: (frustrated) Look, Jason, just prepare the report. I'll back you up.