Question 1

In calculating residual income, the minimum rate of return is set by top management and is the same as the hurdle rate used for return on investment.

Accepted Answer

In calculating residual income, the minimum rate of return is set by top management and is typically higher than the hurdle rate used for return on investment.

Question 2

Decreasing inventories leads to a reduction in return on investment (ROI).

Accepted Answer

Decreasing inventories can actually increase ROI by reducing holding costs and freeing up capital for other investments, thus potentially improving profitability and the return on investment.

Question 3

The direct comparison of the performance of two different investment centres is difficult using return on investment because return on investment is an absolute measure.

Accepted Answer

Return on investment (ROI) is a relative measure, expressed as a percentage, which allows for comparison between different investment centers regardless of their size.

Question 4

Return on investment (ROI) is the most common measure of performance for a revenue centre.

Accepted Answer

ROI is typically used to measure the performance of investment centers, not revenue centers. Revenue centers focus on generating sales and revenue, while investment centers are evaluated based on their ability to generate returns on investments.

Question 5

Economic value added (EVA) can be calculated by multiplying margin by turnover.

Accepted Answer

Economic value added (EVA) is a financial performance measure that calculates the amount of value a company has created or destroyed in relation to the amount of capital invested. It is calculated by subtracting the firm's cost of capital from its net operating profit after taxes (NOPAT). Thus, EVA is not derived by multiplying margin by turnover.

Question 6

The use of residual income encourages managers to accept any project that earns below the minimum rate.

Accepted Answer

The use of residual income actually encourages managers to only accept projects that earn above the minimum rate, as this will increase their residual income and ultimately benefit the business.

Question 7

A production department within the factory, such as assembly, is an example of a profit centre.

Accepted Answer

A production department like assembly is typically considered a cost center, as it focuses on managing costs rather than directly generating profits.

Question 8

The after-tax operating income reduced by the total annual cost of capital is equal to the economic value added.

Accepted Answer

This statement is true, as Economic Value Added (EVA) is calculated by subtracting the total cost of capital from the after-tax operating income. EVA is a financial performance measure that assesses a company's ability to create wealth for its shareholders, and it represents the residual income that remains after all capital costs have been accounted for.

Question 9

Using return on investment to calculate residual income, the dollar cost of capital employed is the actual percentage cost of capital multiplied by the total capital.

Accepted Answer

The answer of Using return on investment to calculate residual...

Question 10

In a centralized company, overall profit margins can mask inefficiencies within the various subdivisions.

Accepted Answer

In a centralized company, the profits of all the subdivisions are combined into one overall profit margin. This can mask inefficiencies within individual subdivisions because their performance may not be reflected in the overall profit margin.

Question 11

A key feature of economic value added (EVA) is that it emphasizes after-tax operating income and the actual cost of capital.

Accepted Answer

Economic value added (EVA) is a financial performance measure that takes into account the after-tax net operating profit and the cost of capital. It encourages companies to focus on increasing their net operating profit after taxes while ensuring that the cost of their capital is covered. Therefore, the statement that EVA emphasizes after-tax operating income and the actual cost of capital is true.

Question 12

Turnover is the ratio of operating income to sales.

Accepted Answer

Turnover is the ratio of sales to assets, not operating income to sales.

Question 13

By centralizing the operating decisions, central management has more freedome to engage in strategic planning and decision making.

Accepted Answer

The answer of By centralizing the operating decisions, central management...

Question 14

A manager assessing an investment using return on investment may make a different decision than had the manager assessed the Investment using residual income.

Accepted Answer

Return on Investment (ROI) is calculated by dividing the profit by the investment amount, whereas residual income deducts the cost of capital from net income. Thus, using these two different methods may lead to different investment decisions.

Question 15

Unlike ROI, residual income can encourage a short-run orientation.

Accepted Answer

Residual income is calculated as the difference between actual income and a target income, which is typically based on a company's cost of capital. This can encourage managers to focus on short-term results that will boost actual income, even if these results are not sustainable in the long run.

Question 16

The practice of delegating decision-making authority to lower levels of management in a company is called centralization.

Accepted Answer

The practice of delegating decision-making authority to lower levels of management is called decentralization. Centralization involves concentrating decision-making authority at higher levels of management.

Question 17

Residual income is sometimes used to overcome the tendency of ROI to discourage investments that are profitable for the company but that lower the division's ROI.

Accepted Answer

This statement is true. Residual income is a method of measuring the profitability of an investment that takes the cost of capital into account. By using residual income, companies are able to evaluate investments based on their actual profitability, rather than just their impact on ROI. This can help to overcome the tendency of ROI to discourage investments that may be profitable for the company overall, but that may lower the division's ROI.

Question 18

Decentralization is usually achieved by creating units called divisions.

Accepted Answer

Decentralization involves the delegation of decision-making power and authority to units or departments within an organization called divisions, hence it is usually achieved by creating divisions.

Question 19

Economic value added (EVA) is similar to ROI in that it links net income to capital employed.

Accepted Answer

EVA is a financial performance measure that calculates the amount of value (or profit) created by a company after subtracting the cost of the capital used to generate that profit. It is similar to ROI (Return on Investment) as both measures compare net income (or profit) to the capital employed. However, EVA takes into account the cost of capital, while ROI does not.

Question 20

Residual income = Operating income - (Minimum rate of return x Average operating assets)

Accepted Answer

This formula calculates the amount of residual income earned by a company, which is the operating income minus the minimum required rate of return multiplied by the average operating assets.

Quiz 12: Performance Evaluation and Decentralization