Chapter 14—Performance Measurement, Balanced Scorecards, and Performance

Rewards

TRUE/FALSE

1. An organization’s values statement identifies fundamental beliefs about what is important to the
organization.

ANS: T PTS: 1 DIF: Easy OBJ: 14-1

2. An organization typically develops a values statement before developing a mission statement.

ANS: F PTS: 1 DIF: Easy OBJ: 14-1

3. The objectives identified in an organization’s values statement must be objective in nature.

ANS: F PTS: 1 DIF: Easy OBJ: 14-1

4. In order to assure achievement of an organizational goal, performance measures must be established

for that goal.

ANS: T PTS: 1 DIF: Easy OBJ: 14-2

5. Internal performance measures focus on the efficiency and effectiveness of an organization’s

production process.

ANS: T PTS: 1 DIF: Easy OBJ: 14-2

6. External performance measures focus on the efficiency and effectiveness of an organization’s

production process.

ANS: F PTS: 1 DIF: Easy OBJ: 14-2

7. The most common external performance measure used for all organizations is financial in nature.

ANS: T PTS: 1 DIF: Moderate OBJ: 14-2

8. Performance measures need not be correlated with the mission of a subunit.

ANS: F PTS: 1 DIF: Moderate OBJ: 14-3

9. Benchmarks for performance measures may be monetary or non-monetary.

ANS: T PTS: 1 DIF: Easy OBJ: 14-3

10. The segment margin of a profit or investment center includes allocated common costs.

ANS: F PTS: 1 DIF: Moderate OBJ: 14-4

11. The segment margin of a profit or investment center does not include allocated common costs.

ANS: T PTS: 1 DIF: Moderate OBJ: 14-4

12. Manipulation of segment expenses may result in the segment margin not being an accurate
performance measure.

ANS: T PTS: 1 DIF: Moderate OBJ: 14-4

13. Profit margin indicates management’s efficiency with regard to sales and expenses.

ANS: T PTS: 1 DIF: Moderate OBJ: 14-4

14. Asset turnover measures the effective use of assets relative to revenue production.

ANS: T PTS: 1 DIF: Moderate OBJ: 14-4

15. Economic value added (EVA) applies the target rate of return to the market value of the capital
invested in a division.

ANS: T PTS: 1 DIF: Moderate OBJ: 14-4

16. Economic value added (EVA) applies the target rate of return to the book value of the assets invested
in a division.

ANS: F PTS: 1 DIF: Moderate OBJ: 14-4

17. Economic value added (EVA) is a more appropriate performance measure when there is a large
difference between the market value of invested capital and the book value of assets.

ANS: T PTS: 1 DIF: Moderate OBJ: 14-4

18. Economic value added (EVA) is focused on short-term performance measurement.

ANS: T PTS: 1 DIF: Moderate OBJ: 14-4

19. Financial measures are lagging indicators.

ANS: T PTS: 1 DIF: Easy OBJ: 14-5

20. Speed of delivery is an example of a leading indicator.

ANS: T PTS: 1 DIF: Moderate OBJ: 14-5

21. Non-financial measures are generally more indicative of productive activity than are financial
performance measures.

ANS: T PTS: 1 DIF: Easy OBJ: 14-6

22. Non-financial measures are generally less timely than are financial performance measures.

ANS: F PTS: 1 DIF: Easy OBJ: 14-6

23. Non-financial measures are generally more appropriate for gauging teamwork than are financial
performance measures.
 ANS: T PTS: 1 DIF: Easy OBJ: 14-6

24. The number of good units or quantity of services that are produced and sold by an organization within
a specified time is referred to as process quality yield.

ANS: F PTS: 1 DIF: Moderate OBJ: 14-7

25. Total units produced during the period divided by the value-added processing time is referred to as
process productivity.

ANS: T PTS: 1 DIF: Moderate OBJ: 14-7

26. The balanced scorecard approach complements measures of past performance with measures of the
drivers of future performance.

ANS: T PTS: 1 DIF: Easy OBJ: 14-8

27. Hourly compensation provides a definite link between performance and reward.

ANS: F PTS: 1 DIF: Moderate OBJ: 14-9

28. In a pay-for-performance plan, defined performance measures must be highly correlated with an
organization’s operational targets.

ANS: T PTS: 1 DIF: Moderate OBJ: 14-9

29. Tax deferral is the most desirable form of tax treatment for employee compensation elements.

ANS: F PTS: 1 DIF: Easy OBJ: 14-9

30. Expatriate workers should receive a compensation package that reflects cost of living factors and
currency fluctuations.

ANS: T PTS: 1 DIF: Easy OBJ: 14-10

31. Cultural differences between countries may make performance evaluation in multinational settings
more difficult.

ANS: T PTS: 1 DIF: Easy REF: 14-10

COMPLETION

1. A statement that identifies fundamental beliefs about what is important to an organization is referred to
as a ________________________________.

ANS: values statement

PTS: 1 DIF: Easy OBJ: 14-1

2. Performance measures that provide a focus on the efficiency and effectiveness of production processes
are referred to as ________________ measures.

ANS: internal
 PTS: 1 DIF: Moderate OBJ: 14-2

3. Performance measures that reflect an organization’s ability to satisfy customers better than rival firms
do are referred to as ________________ measures.

ANS: external

PTS: 1 DIF: Moderate OBJ: 14-2

4. The ratio of income to assets invested is referred to as ______________________________.

ANS: return on investment (ROI)

PTS: 1 DIF: Easy OBJ: 14-4

5. The ratio of income to sales is referred to as ______________________________.

ANS: profit margin

PTS: 1 DIF: Easy OBJ: 14-4

6. The ratio of sales to assets is referred to as ______________________________.

ANS: asset turnover

PTS: 1 DIF: Easy OBJ: 14-4

7. Profit margin x Asset Turnover is often referred to as the _____________________

ANS: DuPont Model

PTS: 1 DIF: Moderate OBJ: 14-4

8. Profit earned in excess of an amount charged for funds committed to a profit center is referred to as
______________________________________.

ANS: residual income

PTS: 1 DIF: Easy OBJ: 14-4

9. A measure of profit produced above the cost of capital is referred to as

_____________________________________.

ANS: economic value added (EVA)

PTS: 1 DIF: Moderate OBJ: 14-4

10. An indicator that reflects the results of past decisions is referred to as a(n)
________________________________.

ANS: lagging indicator

 PTS: 1 DIF: Easy OBJ: 14-5

11. Statistical data about the steps that will create the results desired as referred to as
__________________________________________.

ANS: leading indicators

PTS: 1 DIF: Easy OBJ: 14-5

12. The number of good units or quantity of services that are produced and sold by an organization within
a specified time is referred to as _________________________.

ANS: throughput

PTS: 1 DIF: Moderate OBJ: 14-7

13. Total units produced during the period divided by the value-added processing time is referred to as
_________________________________________.

ANS: process productivity

PTS: 1 DIF: Medium OBJ: 14-7

14. The proportion of good units resulting from activities is referred to as

____________________________________.

ANS: process quality yield

PTS: 1 DIF: Moderate OBJ: 14-4

15. The three components of throughput are _____________________________________,

_______________________________, and ________________________________.

ANS: manufacturing cycle efficiency, process productivity, process quality yield

PTS: 1 DIF: Moderate OBJ: 14-7

MULTIPLE CHOICE

1. Which of the following statements is true about the values statement of an organization?
a. It is used to formulate the mission statement.
b. It reflects the organization’s culture by identifying beliefs about what is important to the
organization.
c. It focuses on long-range plans for the organization.
d. The values contained in the statement must be quantifiable.
ANS: B PTS: 1 DIF: Easy OBJ: 14-1

2. Which of the following statements about an organization’s mission statement is true?

a. The mission statement should express an organization’s purpose.
b. The mission statement should identify how an organization will meet the needs of its
targeted customers.
c. The mission statement must be communicated throughout the organization.
 d. All of the statements are true.
ANS: A PTS: 1 DIF: Easy OBJ: 14-1

3. Variance analysis would be appropriate to measure performance in

a. profit centers.
b. investment centers.
c. cost centers.
d. all of the above.
ANS: D PTS: 1 DIF: Easy OBJ: 14-4

4. Which of the following responsibility centers may be evaluated on the basis of residual income?
a. investment center
b. revenue center
c. profit center
d. cost center
ANS: A PTS: 1 DIF: Easy OBJ: 14-4

5. Net cash flow could be used to measure performance in

a. cost centers and investment centers.
b. revenue centers and profit centers.
c. revenue centers and investment centers.
d. profit and investment centers.
ANS: D PTS: 1 DIF: Easy OBJ: 14-4

6. Using a single performance evaluation criterion for an investment center

a. is most effective because a manager can concentrate on a single goal.
b. can result in manipulation of the performance measure.
c. allows multinational investment centers' performances to be equitably compared.
d. is only appropriate if the criterion is non-monetary.
ANS: B PTS: 1 DIF: Easy OBJ: 14-3

7. A company has set a target rate of return of 16% for its investment center. An investment center
manager in this company would
a. acquire assets that would increase divisional income by more than 16%.
b. sell all assets that do not generate divisional income of more than 16%.
c. acquire assets that would increase sales by more than 16%.
d. acquire any technologically advanced assets that would cause costs to be reduced by 16%
or more.
ANS: A PTS: 1 DIF: Easy OBJ: 14-4

8. In evaluating the performance of a profit center manager, the manager

a. and the sub-unit should be evaluated on the basis of the same costs and revenues.
b. should only be evaluated on the basis of variable costs and revenues of the sub-unit.
c. should be evaluated on all costs and revenues that are controllable by the manager
d. should be evaluated on all costs and revenues that can be directly traced to the sub-unit.
ANS: C PTS: 1 DIF: Easy OBJ: 14-4

9. The Statement of Cash Flows may be superior to the cash budget as a performance evaluation measure
because
 a. cash flows are shown on the accrual basis on the cash budget.
b. the cash budget does not include capital investments.
c. cash flows are arranged by activity.
d. of all the above reasons.
ANS: C PTS: 1 DIF: Moderate OBJ: 14-4

10. The Statement of Cash Flows indicates the cash inflows and outflows from
a. investing, financing, and borrowing activities.
b. operating, investing, and sending activities.
c. merchandising, financing, and investing activities.
d. operating, investing, and financing activities.
ANS: D PTS: 1 DIF: Easy OBJ: 14-4

11. Division A's investment in a new project will raise the overall organization's return on investment if
a. the return on investment on the new project exceeds the target return of the overall
organization.
b. the return on investment on the new project exceeds the return on investment of Division
A.
c. the return on investment on the new project exceeds the overall organization's return on
investment.
d. Division A's return on investment exceeds the return on investment of the overall
organization.
ANS: C PTS: 1 DIF: Easy OBJ: 14-4

12. If sales and expenses both rise by $100,000

a. residual income will increase.
b. return on investment will increase.
c. return on investment will be unchanged.
d. asset turnover will decrease
ANS: C PTS: 1 DIF: Easy OBJ: 14-4

13. Perry Corporation is composed of three operating divisions. Overall, the Perry Corpation has a return
on investment of 20%. Division A has a return on investment of 25%. If Perry Corpation. evaluates its
managers on the basis of return on investment, how would the Division A manager and the Perry
Corporation president react to a new investment that has an estimated return on investment of 23%?

Division A Perry Corporation

Manager President

a. accept accept
b. accept reject
c. reject accept
d. reject reject
ANS: C PTS: 1 DIF: Easy OBJ: 14-4

14. A company's return on investment is affected by a change in

Profit Margin
Asset Turnover on Sales
 a. Yes Yes
b. Yes No
c. No No
d. No Yes

ANS: A PTS: 1 DIF: Easy OBJ: 14-4

15. The return on investment (ROI) ratio measures

a. only asset turnover.
b. only earnings as a percent of sales.
c. both asset turnover and earnings as a percent of sales.
d. asset turnover and earnings as a percent of sales, correcting for the effects of differing
depreciation methods.
ANS: C PTS: 1 DIF: Easy OBJ: 14-4

16. Return on investment (ROI) is a term most often used to express income earned on assets
invested in a business unit. A company's return on investment would increase if sales
a. increased by the same dollar amount as expenses and total assets increased.
b. remained the same and expenses were reduced by the same dollar amount that total assets
increased.
c. decreased by the same dollar amount that expenses increased.
d. and expenses increased by the same percentage that total assets increased.
ANS: B PTS: 1 DIF: Moderate OBJ: 14-4

17. A sub-unit of an organization is evaluated on the basis of its ROI. If this sub-unit's sales and expenses
both increase by $30,000, how will the following measures be affected?

ROI Assert turnover Profit margin

a. increase increase increase

b. indeterminate increase decrease
c. no change increase decrease
d. no change decrease no change
ANS: C PTS: 1 DIF: Moderate OBJ: 14-4

18. Which of the following would be an appropriate alternative to the use of ROI in evaluating the
performance of an investment center?

Residual Net cash Cost and revenue

income flow variance analysis

a. yes yes yes

b. no yes no
c. yes no no
d. yes no yes

ANS: C PTS: 1 DIF: Easy OBJ: 14-4

19. Return on investment is computed by dividing income by

a. contribution margin.
b. inventory turnover.
c. assets invested.
 d. average assets employed.
ANS: C PTS: 1 DIF: Easy OBJ: 14-4

20. Presently, the Comic Book Division of Anderson Publishing Corporation has a profit margin of 30%.
If total sales rise by $100,000, the net result will be
a. an increase in the profit margin ratio to above 30%.
b. a decrease in the profit margin ratio to below 30%.
c. no change in the profit margin ratio.
d. a change in the profit margin ratio that cannot be determined from this information.
ANS: C PTS: 1 DIF: Moderate OBJ: 14-4

21. Profit margin indicates the portion of sales that

a. covers fixed expenses.
b. is not used to cover expenses.
c. equals contribution margin.
d. equals product contribution margin.
ANS: B PTS: 1 DIF: Easy OBJ: 14-4

22. Profit margin equals

a. income divided by sales.
b. incomes divided by average inventory.
c. income divided by average assets.
d. income divided by average stockholder's equity.
ANS: A PTS: 1 DIF: Easy OBJ: 14-4

23. The Du Pont model measures

a. residual income.
b. return on investment.
c. throughput.
d. profit.
ANS: B PTS: 1 DIF: Easy OBJ: 14-4

24. In the Du Pont model, profit margin is a ratio of

a. income to sales.
b. income to assets.
c. sales to income.
d. sales to assets.
ANS: A PTS: 1 DIF: Easy OBJ: 14-4

25. The Du Pont model measures ROI as it is affected by

a. contribution margin and asset turnover.
b. profit margin and asset turnover.
c. asset turnover.
d. profit margin.
ANS: B PTS: 1 DIF: Easy OBJ: 14-4

26. Residual income is used as a performance measure in

a. profit centers.
b. cost centers.
 c. investment centers.
d. revenue centers.
ANS: C PTS: 1 DIF: Easy OBJ: 14-4

27. If a new project generates a positive residual income, the

a. project's return on investment is less than the target rate.
b. project's return on investment is greater than the target rate.
c. project's return on investment is equal to the target rate.
d. relationship between the project's return on investment and the target rate cannot
necessarily be determined.
ANS: B PTS: 1 DIF: Easy OBJ: 14-4

28. A prospective project under consideration by the Internet Division of Communications Corporation.
has an estimated residual income of $(20,000). If the project requires an investment of $400,000, the
a. project generates a negative return on investment.
b. project's return on investment is zero.
c. project's return on investment is 5% less than the company's target rate.
d. company's target rate is 15%
ANS: C PTS: 1 DIF: Moderate OBJ: 14-4

29. Residual income is the

a. contribution margin of an investment center, less the imputed interest on the invested
capital used by the center.
b. contribution margin of an investment center, plus the imputed interest on the invested
capital used by the center.
c. income of an investment center, less the imputed interest on the invested capital used by
the center.
d. income of an investment center, plus the imputed interest on the invested capital used by
the center.
ANS: C PTS: 1 DIF: Easy OBJ: 14-4

30. Residual income is an example of a ____________ performance measurement.

a. long-term
b. short-term
c. qualitative
d. profit center
ANS: B PTS: 1 DIF: Easy OBJ: 14-4

31. If a division generates a positive residual income then the division's

a. asset turnover was very high.
b. profitability was greater than that of other divisions in the company.
c. performance was above expectations.
d. actual return on investment exceeds the division's target return.
ANS: D PTS: 1 DIF: Easy OBJ: 14-4

32. Residual income is determined as

a. income times the asset turnover rate.
b. income times the inventory turnover rate.
c. income minus (asset base times target rate of return).
d. sales minus (asset base times target rate of return).
 ANS: C PTS: 1 DIF: Easy OBJ: 14-4

33. Residual income is used as a performance measure in which of the following types of centers?

Revenue Investment Profit

a. yes no yes
b. yes yes yes
c. no yes yes
d. no yes no

ANS: D PTS: 1 DIF: Easy OBJ: 14-4

34. An increase in a corporation's target rate would result in a(n)

a. increase in residual income.
b. decrease in return on investment.
c. decrease in residual income.
d. decrease in both residual income and return on investment.
ANS: C PTS: 1 DIF: Easy OBJ: 14-4

35. All other things being equal, an increase in sales price would increase
a. asset turnover.
b. profit margin.
c. residual income.
d. all of the above.
ANS: D PTS: 1 DIF: Easy OBJ: 14-4

36. If sales and expenses both rise by $100,000, profit margin will
a. decrease and asset turnover will decrease.
b. increase and asset turnover will decrease.
c. decrease and asset turnover will increase.
d. increase and asset turnover will increase.
ANS: C PTS: 1 DIF: Moderate OBJ: 14-4

37. Asset turnover equals

a. income divided by average assets.
b. sales divided by assets.
c. sales divided by average assets.
d. assets divided by sales.
ANS: C PTS: 1 DIF: Easy OBJ: 14-4

38. The information below relates to costs, revenues, and assets anticipated in the Shoe Division of BVD
Footwear Corporation:

Sales $ 4,000,000
Variable costs 75% of sales
Average assets employed $12,000,000
Fixed costs 0

How would each of the following measures be affected if sales rise by $5,000 in the Shoe Division?
 ROI Asset turnover Profit margin

a. increase increase increase

b. increase no change increase
c. increase increase no change
d. no change no change increase
ANS: C PTS: 1 DIF: Easy OBJ: 14-4

39. A division of Watters Corporation reported a return on investment of 20% for a recent period. If the
division's asset turnover was 5, its profit margin must have been
a. 100%
b. 4%
c. 25%
d. 2%
ANS: B
ROI = Profit Margin x Asset Turnover
.20 = PM x 5
PM = ROI/Asset Turnover
PM = .04 or 4%

PTS: 1 DIF: Easy OBJ: 14-4

40. Which measure is limited by the fact that it uses accounting income?
a. ROI
b. RI
c. EVA
d. All of the above
ANS: D PTS: 1 DIF: Easy OBJ: 14-4

41. The Candy Division of Confections Corporation has the following segment information:

Assets available for use $1,800,000

Target rate of return 10%
Residual income $ 270,000

What was Candy Division's return on investment?

a. 15%
b. 10%
c. 25%
d. 20%
ANS: C
ROI = Income / Assets Invested

Income = Residual Income + (Target Rate * Assets)

= $270,000 + (.10 * $1,800,000)
= $450,000

ROI = $(450,000/1,800,000)
= 25%

PTS: 1 DIF: Moderate OBJ: 14-4

 United Toy Company

The Block Division of United Toy Company had the following financial data for the year:

Assets available for use $1,000,000 Book Value

$1,500,000 Market Value
Residual income $100,000
Return on investment 15%

42. Refer to United Toy Company. What was the Block Division’s segment income?
a. $150,000
b. $100,000
c. $250,000
d. $ 50,000
ANS: A
Segment Income = ROI * BV of Total Assets
= 0.15 * $1,000,000
= $150,000

PTS: 1 DIF: Moderate OBJ: 14-4

43. Refer to United Toy Company. What was the target rate of return for United Toy Company?
a. 10%
b. 15%
c. 25%
d. 5%
ANS: D
Net Income - (Target Rate x Asset Base) = Residual Income
$150,000 - (Target Rate x $1,000,000) = $100,000
(Target Rate x $1,000,000) = $50,000
Target Rate = 5.0%

PTS: 1 DIF: Moderate OBJ: 14-4

44. Refer to United Toy Company. If the manager of the Block Division is evaluated based on return on
investment, how much would she be willing to pay for an investment that promises to increase net
segment income by $50,000?
a. $ 50,000
b. $ 333,333
c. $1,000,000
d. $ 500,000
ANS: B
$50,000 / 0.15 = $333,333

PTS: 1 DIF: Moderate OBJ: 14-4

45. Refer to United Toy Company. If expenses increased by $20,000 in the Block Division,
a. return on investment would decrease.
b. residual income would increase.
c. the target rate of return would decrease.
 d. asset turnover would decrease.
ANS: A PTS: 1 DIF: Easy OBJ: 14-4

Boston Company

Illinois Division of the Boston Company has the following statistics for its most recent operations:

Assets available for use (Market Value) $3,600,000

Assets available for use (Book Value) $2,000,000
Illinois Division's return on investment 25%
Illinois Division's residual income 200,000
Return on investment (entire Boston Company) 20%

46. Refer to Boston Company. Compute EVA assuming the cost of capital is 10% and the tax rate is 40%.
a. $ 90,000
b. $ 150,000
c. $0
d. $ (60,000)
ANS: D
EVA = After Tax Net Income - (Cost of Capital x Market Value of Assets)
EVA = (($2,000,000 * .25) x .60) - (.10 x $3,600,000)
EVA = $(300,000 - 360,000)
EVA = $(60,000)

PTS: 1 DIF: Moderate OBJ: 14-4

47. Refer to Boston Company. What is the target rate of return in Boston Company?
a. 25%
b. 20%
c. 15%
d. 10%
ANS: C
Net Income - (Target Rate of Return x Total assets) = Residual Income
$500,000 - (Target Rate of Return * $2,000,000) = $200,000
Target Rate of Return * $2,000,000 = $300,000
Target Rate of Return = 15%

PTS: 1 DIF: Moderate OBJ: 14-4

48. Refer to Boston Company. If Boston Company evaluates its managers on the basis of return on
investment, the manager of Illinois Division would invest in a project costing $100,000 only if it
increased net segment income by at least
a. $10,000.
b. $15,000.
c. $20,000.
d. $25,000.
ANS: D
$100,000 * .25 = $25,000

PTS: 1 DIF: Moderate OBJ: 14-4

49. Juneau Corporation has a target return of 15%. If a prospective investment has an estimated return on
investment of 20%, and a residual income of $10,000, what is the estimated cost of the investment?
a. $200,000
b. $ 66,667
c. $ 50,000
d. The answer can't be determined from this information.
ANS: A

0.20 - 0.15 = 0.05 residual income

$10,000 / 0.05 = $200,000

PTS: 1 DIF: Moderate OBJ: 14-4

50. The Vinyl Division of Plastic Products Company is considering an investment in a new project. The
project has an estimated cost of $1,000,000. If Plastic Products Company has a target rate of return of
12%, how large does the return on investment on this project need to be to generate $150,000 of
residual income?
a. 15%
b. 12%
c. 25%
d. 27%
ANS: D
(ROI x Total Assets) - (Target Rate x Total Assets) = Residual Income
(ROI x $1,000,000) - (0.12 x $1,000,000) = $150,000
(ROI x $1,000,000) = $270,000
ROI = 27%

PTS: 1 DIF: Moderate OBJ: 14-4

51. In the North Division of Orient Company, segment income for the most recent year exceeded residual
income by $15,000. Also, return on investment exceeded the target rate of return by 10%. What was
the level of investment in the North Division for the most recent year?
a. $ 15,000
b. $100,000
c. $150,000
d. An answer can't be determined from this information.
ANS: C
$15,000/0.10 = $150,000

PTS: 1 DIF: Difficult OBJ: 14-4

ADR Company

ADR Co. has established a target rate of return of 16% for all divisions. For the most recent year,
Division D generated sales of $10,000,000 and expenses of $7,500,000. Total assets at the beginning
of the year were $5,000,000 and total assets at the end of the year were $7,000,000.

52. Refer to ADR Company. In the most recent year, what was Division D's residual income?
a. $ 960,000
b. $1,380,000
 c. $1.540,000
d. $1,700,000
ANS: C
Residual Income = $(10,000,000 - 7,500,000) - ((.16) * $6,000,000)
= $(2,500,000 - 960,000)
=$1,540,000

PTS: 1 DIF: Moderate OBJ: 14-4

53. Refer to ADR Company. For the most recent year, what was Division D's return on investment ?
a. 20.83 %
b. 35.71 %
c. 41.67 %
d. 50.00 %
ANS: C
ROI = Net Income/Average Total Assets
= $(2,500,000/6,000,000)
= 41.67%

PTS: 1 DIF: Moderate OBJ: 14-4

54. The Movie Division of Media Company reported the following results for a recent year

Sales $8,000,000
Expenses 6,250,000
Total assets (1/1) 5,000,000
Total assets (12/31) 5,400,000

What was the profit margin for the Movie Division?

a. 68%
b. 35%
c. 32%
d. 22%
ANS: D
Profit Margin = Gross Margin/Sales
=$(1,750,000/8,000,000)
=22%

PTS: 1 DIF: Moderate OBJ: 14-4

55. The Movie Division of Media Company reported the following results for a recent year

Sales $8,000,000
Expenses 6,250,000
Total assets (1/1) 5,000,000
Total assets (12/31) 5,400,000

What was the asset turnover ratio of the Movie Division?

a. 1.538
b. 2.97
c. 0.650
 d. 1.20
ANS: A
$8,000,000/($((5,000,000 + 5,400,000)/2) = 1.538

PTS: 1 DIF: Moderate OBJ: 14-4

56. Wrigley Division of Chicago Delights, is evaluated based on residual income generated. In the most
recent year, the Wrigley Division generated a residual income of $2,000,000 and net income of
$5,000,000. The target rate of return for all divisions of Chicago Delights is 20%. What was the return
on investment for the Wrigley Division?
a. 40%
b. 13%
c. 20%
d. 33%
ANS: D
(Net Income) - (Target Rate x Total Assets) = Residual Income
($5,000,000) - (0.20 x Total Assets) = $2,000,000
(0.20 x Total Assets) = $3,000,000
Total Assets = $15,000,000
ROI = (5,000,000/15,000,000)
ROI = 33%

PTS: 1 DIF: Moderate OBJ: 14-4

57. Qualitative non-financial performance measures

a. are usually the most well-received by managers.
b. often reflect long-term organizational goals better than financial performance measures.
c. can only be developed in the production area of an organization.
d. is limited by the number of critical success factors defined by the organization.
ANS: B PTS: 1 DIF: Easy OBJ: 14-6

58. Relative to qualitative performance measures, quantitative performance measures are less
a. subject to manipulation.
b. dependent on accounting information.
c. effective in the pursuit of organizational goals.
d. subjective.
ANS: D PTS: 1 DIF: Easy OBJ: 14-6

59. Improved effectiveness and efficiency of a product is considered a ______ performance measurement?
a. subjective
b. financial
c. quantitative
d. qualitative
ANS: D PTS: 1 DIF: Easy OBJ: 14-6

60. Non-financial performance measures (NFPMs) are better than financial measures in that NFPMs
a. provide a better indication of customer satisfaction.
b. may better predict the direction of future cash flows.
c. directly measure how well an organization does those things that create shareholder value.
d. all of the above
 ANS: D PTS: 1 DIF: Easy OBJ: 14-6

61. In selecting non-financial performance measures managers should choose measures that reflect
a. qualitative characteristics that point out sub-optimization activities and throughput
bottlenecks.
b. both short-term and long-term measures related to critical success factors.
c. long-term supplier satisfaction levels.
d. short-term financial viability.
ANS: B PTS: 1 DIF: Easy OBJ: 14-6

62. Which of the following would be considered a non-financial performance measurement?

a. increase in market share
b. variances from standards
c. number of customer complaints
d. cost of engineering changes
ANS: C PTS: 1 DIF: Easy OBJ: 14-6

63. Which type of financial measure better predicts the direction of future cash flows?

Non-financial Measures Financial Measures

a. yes yes
b. yes no
c. no no
d. no yes

ANS: D PTS: 1 DIF: Easy OBJ: 14-6

64. Which of the following would be classified as a non-financial critical success factor?

Technical Manufacturing Manufacturing

Quality Excellence Efficiency Effectiveness

a. no no no yes
b. yes no no no
c. yes yes yes yes
d. yes yes no yes

ANS: C PTS: 1 DIF: Easy OBJ: 14-5

65. Which of the following is necessary for any valid performance measurement?
a. It must be part of the financial accounting system in use.
b. It must be quantifiable.
c. Goal congruence must be promoted by its use.
d. It must be financial in nature.
ANS: C PTS: 1 DIF: Easy OBJ: 14-3

66. Process quality yield is used in the measurement of

a. throughput.
b. cash flows.
c. asset turnover.
d. profit margin.
 ANS: A PTS: 1 DIF: Easy OBJ: 14-7

67. An increase in productive processing time will increase

a. throughput.
b. process yield.
c. return on investment.
d. productive capacity.
ANS: A PTS: 1 DIF: Easy OBJ: 14-7

68. Which of the following is the throughput measure?

a. Processing time/Total time
b. Good units/Total time
c. Good units/Processing time
d. Total units/Total time
ANS: B PTS: 1 DIF: Easy OBJ: 14-7

69. Productive capacity is a measure used in computing

a. residual income.
b. net cash flow.
c. return on investment.
d. throughput.
ANS: D PTS: 1 DIF: Easy OBJ: 14-7

70. Process quality yield reflects the proportion of

a. good units to bad units.
b. time required to produce a good unit.
c. total units manufactured that are good.
d. total time spent to time available.
ANS: C PTS: 1 DIF: Easy OBJ: 14-7

71. When inventory sits idle in a department, this would not affect the department's
a. processing time.
b. throughput.
c. process quality yield.
d. dollar days.
ANS: C PTS: 1 DIF: Easy OBJ: 14-7

72. Process quality yield reflects the proportion of

a. time it takes to make a good unit.
b. good units to defective units.
c. total time spent to total time available.
d. total units produced that are good units.
ANS: D PTS: 1 DIF: Easy OBJ: 14-7

73. Holding total production in units constant, as the proportion of defective units to total units declines,
all of the following measures will be affected, except
a. total unit sales.
b. throughput.
c. process quality yield.
 d. process productivity.
ANS: D PTS: 1 DIF: Easy OBJ: 14-7

74. Process productivity is calculated as

a. total units divided by non-value-added processing time.
b. total units divided by value-added processing time.
c. value-added processing time divided by total units.
d. value-added processing divided by total time.
ANS: B PTS: 1 DIF: Easy OBJ: 14-7

75. Which of the following would not be an appropriate cost driver to measure internal failure?
a. design error
b. product failure
c. machine reliability
d. operator error
ANS: B PTS: 1 DIF: Easy OBJ: 14-7

76. When assessing performance, one way to compensate for differences among divisions of a
multinational organization would be for the parent company to
a. use different target rates of return to compute residual incomes.
b. modify the return on investment calculation so that foreign currency fluctuations are
removed from all financial statement figures.
c. classify all domestic divisions as investment centers and all foreign divisions as profit
centers.
d. use financial performance measures for units whose records are kept in the domestic
currency and non-financial measures for units whose records are kept in a foreign
currency.
ANS: A PTS: 1 DIF: Moderate OBJ: 14-10

Laredo Company

Laredo Company is a manufacturer of electronic components. The following manufacturing

information is available for the month of May:

Good units manufactured 40,000

Value-added hours of manufacturing time 20,000
Total units manufactured 50,000
Total hours of manufacturing time 30,000

77. Refer to Laredo Company. What is the throughput per hour?

a. 1.3 units (rounded)

b. 2.0 units
c. 1.8 units
d. .8 units
ANS: A

x x = 1. units
 PTS: 1 DIF: Easy OBJ: 14-7

78. Refer to Laredo Company. What is the process quality yield?

a. 50%
b. 75%
c. 80%
d. 125%
ANS: C

= 80%

PTS: 1 DIF: Easy OBJ: 14-7

Beaumont Company

One of the products manufactured by Beaumont Company is a plastic disk. The information below
relates to the Disk Production Department:

Good units produced 200,000

Units started in production 250,000
Processing time (budgeted hours) 425
Processing time (total hours) 400
Value-added processing time 300

79. Refer to Beaumont Company. What is the process quality yield in the Disk Production Department?
a. 75%
b. 44%
c. 80%
d. 125%
ANS: C

= 80%

PTS: 1 DIF: Easy OBJ: 14-7

80. Refer to Beaumont Company. What is the throughput per hour in the Disk Production Department?
a. 470 units
b. 500 units
c. 625 units
d. 667 units
ANS: B

x x = 500 units

PTS: 1 DIF: Moderate OBJ: 14-7

81. Refer to Beaumont Company. What is the process productivity in the Disk Production Department?
a. 588
b. 625
c. 667
d. 833
ANS: D

= 833 units

PTS: 1 DIF: Moderate OBJ: 14-7

82. Which of the following is not a balanced scorecard category?

a. financial measures
b. environmental measures
c. business process measures
d. personnel measures
ANS: B PTS: 1 DIF: Easy OBJ: 14-8

83. A primary purpose of a balanced scorecard is to give

a. managers a way to judge past performance.
b. stockholders a way to judge current performance.
c. managers a way to forecast future performance.
d. stockholders a way to tie strategy to profitability.
ANS: C PTS: 1 DIF: Moderate OBJ: 14-8

84. In a balanced scorecard, measurements should be directly linked to

a. organizational strategy and values.
b. the cost management system.
c. current organizational profitability.
d. activity-based management concepts.
ANS: A PTS: 1 DIF: Easy OBJ: 14-8

85. Customer measures on the balanced scorecard should be

Internal External Monetary Non-monetary

a. yes no no yes
b. no yes yes no
c. no yes no yes
d. yes yes yes yes

ANS: D PTS: 1 DIF: Moderate OBJ: 14-8

86. A balanced scorecard

a. records the variances between budgeted and actual revenues and expenses.
b. can be used at multiple organizational levels by redefining the categories and
measurements.
c. is most concerned with organizational financial solvency and business processes.
d. all of the above.
 ANS: B PTS: 1 DIF: Moderate OBJ: 14-8

87. On a balanced scorecard, which of the following would be most appropriate to measure customer
service?
a. Rapid time-to-market of new products
b. Corporate financial profits
c. On-time delivery
d. Decrease in reworked products
ANS: C PTS: 1 DIF: Easy OBJ: 14-8

88. On a balanced scorecard, which of the following would be most appropriate to measure production
process integrity?
a. Rapid time-to-market of new products
b. Corporate financial profits
c. Low employee turnover
d. Decrease in reworked products
ANS: D PTS: 1 DIF: Easy OBJ: 14-8

89. On a balanced scorecard, which of the following would be most appropriate to measure innovation:
a. Rapid time-to-market of new products
b. Corporate financial profits
c. On-time delivery
d. Manufacturing cycle efficiency
ANS: A PTS: 1 DIF: Easy OBJ: 14-8

90. On a balanced scorecard, which of the following would be most appropriate to measure financial
performance?
a. Market share
b. Customer retention
c. Percentage of sales from new products
d. Investment in intellectual capital
ANS: A PTS: 1 DIF: Easy OBJ: 14-8

91. A primary characteristic of a performance management system is

a. consistency at all levels in the organization.
b. adaptability to differing situations in the organization.
c. efficiency of application to all individuals in the organization.
d. flexibility to delay rewards although performance objectives have been met.
ANS: B PTS: 1 DIF: Moderate OBJ: 14-9

92. Which of the following would not normally affect the compensation strategy of a firm?
a. organizational goals
b. location of firm
c. competition
d. number of subsidiaries
ANS: D PTS: 1 DIF: Easy OBJ: 14-9

93. Managers should be paid

a. on a periodic basis.
b. based on results achieved.
 c. using ESOPs.
d. on a piece rate basis.
ANS: B PTS: 1 DIF: Easy OBJ: 14-9

94. Financial incentives are

a. different from monetary rewards
b. the same thing as a salary element
c. provided to all employee groups.
d. available to top management whose performance exceeds targeted objectives
ANS: D PTS: 1 DIF: Easy OBJ: 14-9

95. Which of the following steps in the performance reward plan model comes before the others listed?
a. set performance rewards
b. identify performance measures
c. determine reward
d. identify critical success factors
ANS: D PTS: 1 DIF: Easy OBJ: 14-9

96. Objectives for a pay plan

a. are not needed in a performance-based plan.
b. must be stated for a performance-based plan to work.
c. are essential for a periodic compensation plan to be successful.
d. are unnecessary for a merit pay plan.
ANS: B PTS: 1 DIF: Easy OBJ: 14-9

97. Merit pay is

a. a contingent amount of pay that is earned by managers whose subunits meet a target rate
of return.
b. always for a limited period of time and must be re-earned each period.
c. any pay earned when the company is profitable.
d. a pay increment received when a specific performance level is achieved.
ANS: D PTS: 1 DIF: Easy OBJ: 14-9

98. Contingent pay

a. is always paid in stock options.
b. is the sole source of pay an employee receives from his/her employer.
c. is received in addition to the basic wage and is dependent upon performance exceeding
some performance objective.
d. can only apply to individual performance.
ANS: C PTS: 1 DIF: Easy OBJ: 14-9

99. Piece rate pay

a. is a suitable pay plan for low-IQ workers.
b. involves a salary plus pay for each unit produced or carried out.
c. encourages quality output.
d. does not encourage workers to look at the company's well being.
ANS: D PTS: 1 DIF: Easy OBJ: 14-9

100. Which of the following pay plans encourages the improvement of the overall company's well-being?
 a. monthly salary
b. cafeteria plan
c. profit sharing
d. pensions
ANS: C PTS: 1 DIF: Easy OBJ: 14-9

101. Which performance plan is most tied to company objectives?

a. profit sharing
b. pensions
c. piece rate
d. merit pay
ANS: A PTS: 1 DIF: Easy OBJ: 14-9

102. Which performance plan best promotes quality of the product or service?
a. piece rate
b. health insurance
c. pensions
d. profit sharing
ANS: D PTS: 1 DIF: Easy OBJ: 14-9

103. Employee stock ownership in the employees' firm

a. will encourage short term earnings growth patterns.
b. will encourage employees to take a longer term perspective regarding their performance in
the company.
c. is not suitable for hourly or salaried employees.
d. is common for management in American firms.
ANS: B PTS: 1 DIF: Moderate OBJ: 14-9

104. A pay plan that gives an employee cash or stock equal to the difference between some specified stock
price and the quoted market price at some future time period is
a. stock appreciation rights.
b. an ESOP.
c. profit sharing.
d. merit pay.
ANS: A PTS: 1 DIF: Easy OBJ: 14-9

105. Which of the following types of employee compensation are tax-exempt?

a. contingent pay
b. profit sharing
c. cafeteria plans
d. stock appreciation rights
ANS: D PTS: 1 DIF: Moderate OBJ: 14-9

106. The traditional compensation package provides

a. fixed monthly or weekly salaries.
b. the same salary structure for all groups of employees.
c. no incentive for non-top management to improve performance.
d. no need to include incentive compensation.
ANS: C PTS: 1 DIF: Easy OBJ: 14-9
107. Compensation packages for executives of American firms
a. are beginning to emphasize the long-term commitment executives should have in the firm.
b. are considered comparable to packages earned by European and Asian executives.
c. are shifting towards lower percentages of annual incentives.
d. are shifting away from long-term awards.
ANS: A PTS: 1 DIF: Easy OBJ: 14-9

108. A pay plan that does not encourage the overall company good is
a. profit sharing.
b. an employee stock option plan.
c. contingent pay.
d. monthly salary.
ANS: D PTS: 1 DIF: Easy OBJ: 14-9

109. Which performance plan is most motivating?

a. health insurance
b. piece rate
c. hourly wages
d. pensions
ANS: D PTS: 1 DIF: Moderate OBJ: 14-9

110. Expatriate employees

a. should be paid a base comparable to what he/she was earning domestically.
b. will be paid more than corresponding managers in their home country.
c. will always pay taxes in the country in which they are based.
d. should receive retirement benefits based on local currencies.
ANS: A PTS: 1 DIF: Moderate OBJ: 14-9

111. If performance measures are perfect proxies for organizational goals,

a. sub-optimization will be enhanced.
b. sub-unit managers will strive to achieve organizational goals.
c. sub-units can all be decentralized.
d. residual income will rise.
ANS: B PTS: 1 DIF: Easy OBJ: 14-7

SHORT ANSWER

1. Answer the following questions regarding economic value added (EVA):

a. What is it intended to do?

b. How is it measured?
c. How is the measurement different than that of RI?
d. Why is EVA a better performance measure of RI?
e. What is the major problem with using EVA as a long-term performance measure?

ANS:

a. The purpose of EVA is to more directly align the interests of common shareholders and
managers.
 b. EVA = A/Tax profit - (market value of invested capital x cost of capital %).
c. EVA uses after-tax profit, cost of capital and market value of assets invested. RI uses segment
income, target rate of return and book value of assets invested.
d. EVA is a better performance measure than RI, because it recognizes that there may be a
significant difference between book value and market value of assets. The market value of a
company is reflected in stock prices which are another measure of performance evaluation.
e. EVA includes the increased investment immediately even though significant income may not
occur until sometime in the future. Most investments will show decreased short-term
performance (EVA) and may cause a company to refuse projects that are profitable in the long-
term (similar to shortcomings of the payback method).

PTS: 1 DIF: Moderate OBJ: 14-4

2. What items affect comparability of different divisions within the same company on the basis of EVA,
ROI and RI?

ANS:

a. Each measure is based on accounting income which can be manipulated in the short-term by
accounting methods used, which can differ between investment centers.
b. The measurement of the asset base is affected by the choice of what to include, and may
include items that relate to decisions made by prior managers.
c. All measures focus primarily on how well the segments do in isolation with results compared
to prior years for the same segment, rather than relative company-wide objectives.

PTS: 1 DIF: Moderate OBJ: 14-4

3. Why is it likely that a subordinate manager would be more attentive to certain performance measures
than overall corporate objectives to guide his decision making?

ANS:
Managers are evaluated based on how their actual results compare to specific measures of
performance. These performance measures are intended to be surrogates for the overall corporate goals
as they apply to specific managers. Thus performance measures are selected by the extent to which
they are good proxies for corporate goals (that is the extent to which they operationally define, and are
consistent with, corporate goals) and are intended to be major focal points for managers.

PTS: 1 DIF: Moderate OBJ: 14-5

4. What are some of the major problems associated with accrual-based accounting performance
measures?

ANS:
There are two major problems with accrual-based accounting numbers. The first problem is that they
can be easily manipulated by managers. For example, the timing of end of period transactions can be
accelerated or delayed to affect performance measures. Secondly, accounting measures cannot capture
all corporate goals. Accounting measures are particularly inappropriate to measure qualitative changes
in the workforce, qualitative changes in products, and achievement of social and non-monetary
objectives. Additionally, accounting measures reflect only a short-term perspective of operations rather
than a long-range goal orientation.

PTS: 1 DIF: Moderate OBJ: 14-5

5. What distinct advantage does a return on investment measure have over a residual income measure?
Explain.

ANS:
The advantage of ROI measure over RI is that ROI facilitates a comparison of organizational sub-units
of differing sizes. Because ROI is a performance measure that automatically scales for size, large and
small sub-units can be compared to each other (subject to all the factors that should be considered
when two units in different industries, different geographical areas, etc. are compared).

PTS: 1 DIF: Moderate OBJ: 14-4

6. How can return on investment result in sub-optimization when it is used as a performance measure?

ANS:
Because performance measures are used to reward performance, managers use them as decision
criteria when they evaluate alternative courses of action. For example, if ROI is the performance
criterion, a division manager will only invest in new projects that will result in an increase in his/her
division's ROI. This is sub-optimal if the overall organization would be better off by the division
manager's investment in available projects with lower ROIs.

PTS: 1 DIF: Moderate OBJ: 14-4

7. Define residual income. Evaluate residual income as a measure of performance.

ANS:
Residual income is the remainder of net profit once a target cost of capital has been taken into
consideration. Residual income is determined by deducting from net income a prescribed or imputed
interest charge on assets. This method allows an organization to use different rates of interest for
various organizational assets. A main advantage of using RI is that it overcomes some limitations of
ROI (sub-optimization).

PTS: 1 DIF: Moderate OBJ: 14-4

8. What are some common problems encountered in determining ROI?

ANS:
Net income and investment involved can both be calculated several ways. Multiple calculations are
often presented to show the different factors that affect ROI, changes in sales, expenses, and capital
investments.

PTS: 1 DIF: Moderate OBJ: 14-4

9. Discuss the ways in which management uses flexible budgets.

ANS:
Flexible budgets are important to managers in performing a variety of functions. Formulating budgets
commits certain activities agreed to during the planning process to specific monetary amounts. The
flexible budget provides the means to estimate costs at various levels of activity. The control function
is undertaken to assure that actual operations meet planned operations. Through this function,
deviations are determined and variances can be ascertained. Managers also use flexible budgets in
performance evaluation. Evaluation is more meaningful with valid and accurate data to make the
process of evaluation beneficial to all involved.

PTS: 1 DIF: Moderate OBJ: 14-4

10. Identify the steps to follow in establishing the performance reward system for a company.

ANS:
The steps are in the following order:
1. set strategic goals
2. identify the critical success factors
3. set the compensation strategy
4. identify performance measures
5. set performance rewards
6. measure/monitor performance
7. determine rewards

PTS: 1 DIF: Moderate OBJ: 14-9

11. Discuss pay-for-performance plans.

ANS:
Employees should be encouraged by compensation plans to perform and be loyal to the organization.
Performance measures should be related to a company's operational targets. These performance
measures do not have to be evenly weighted. Management can assign higher weights to more
important performance measures as they are related to the corporate goals.

PTS: 1 DIF: Moderate OBJ: 14-9

12. Discuss the rethinking taking place regarding the time frame used in American business performance
systems.

ANS:
Historically, American time frames for performance has been short term, often only one year.
Presumably management tries to do what is best for the firm and its owners. Thus, shareholder wealth
maximization should be the primary focus of management. Short term profit maximization does not
necessarily result in long-run shareholder wealth maximization.

To encourage this different attitude, employees and management are being asked to take a longer run
perspective. This is enhanced with employee stock ownership in their firm.

PTS: 1 DIF: Moderate OBJ: 14-9

13. Deferred compensation techniques are currently used in the American work place. What are they and
how do they benefit the employer and the employee?

ANS:
Deferred compensation is pay that was earned on current performance but is paid later to the
employee. The compensation may include profit sharing plans, pensions, and stock-based plans like
ESOPs. The payment by the employer can be deducted currently for tax purposes but the employee
does not recognize it as income until it is received. In stock option plans, earnings in the plan are not
taxable to the employee until the plan is distributed. Size of the plans are affected by the firm's stock
value and encourage employees to take a more positive attitude about the company's future.

PTS: 1 DIF: Moderate OBJ: 14-9

 14. List the five general criteria that should be considered when designing a performance measurement
system.

ANS:
1. The measures should be established to assess progress toward the organizational mission
and its related goals and objectives.
2. The persons being evaluated should be aware of the measurements used and have some
input in developing them.
3. The persons being evaluated should have the appropriate skills, equipment, information, and
authority to be successful under the measurement system.
4. Feedback of accomplishment should be provided in a timely and useful manner.
5. The system should be flexible to adapt to new conditions in the organizational environment.

PTS: 1 DIF: Moderate OBJ: 14-3

15. What are five advantages that nonfinancial performance measures have over financial performance
measures

ANS:
Answers will vary on this. The major advantages are listed below:

Compared to financial measures, nonfinancial performance measures are more:

• relevant to nonmanagement employees who are generally more familiar with nonfinancial items
(such as times and quantities) than financial items (such as costs or profits)
• timely than historical financial data and, thus, more apt to indicate where problems lie or where
benefits can be obtained
• reflective of the leading indicators of activities that create shareholder wealth, such as
manufacturing and delivering quality goods and services and providing service for the customer
• causative of goal-congruent behavior (rather than suboptimization) because they promote
long-term success rather than the short-term success promoted by financial measures
• integrated with organizational effectiveness because they can be designed to focus on
processes rather than simply outputs
• indicative of productive activity and the direction of future cash flows
• appropriate for gauging teamwork because they can focus on outputs that result from
organizational effort (such as quality) rather than inputs (such as costs)
• cross functional than financial measures, which are generally related to one function
• comparable for benchmarking externally than financial measures (which can be dramatically
affected by differences in accounting methods)
• aligned with the reward system because they are more likely to be under the control of
lower-level employees than are financial measures

PTS: 1 DIF: Moderate OBJ: 14-6

PROBLEM

Cake Division

The Cake Division is one of the operating units of Baking Solutions, Inc. The following operating
data of the division is presented below:

Sales $3,000,000
Profit margin 10%
Target return 15%
 Residual income $ 60,000

1. Refer to the Cake Division. What was the segment income of the Cake Division for the year?

ANS:
Segment income = Profit Margin * Sales = .10 * $3,000,000 = $300,000

PTS: 1 DIF: Easy OBJ: 14-4

2. Refer to Cake Division. What was the return on investment for the Cake Division?

ANS:
ROI = Segment Income/Assets
Segment Income = $3,000,000 * .10 = $300,000
Assets = ($300,000 - $60,000)/.15 = $1,600,000
ROI = $300,000/$1,600,000 = 18.75%

PTS: 1 DIF: Moderate OBJ: 14-4

Eastern Division

The Eastern Division of Illinois Chemical Co. produced the following operating results for the
previous year:

Sales $10,000,000
Segment income 1,500,000
Assets 6,000,000

The Eastern Division is considering a $1,000,000 investment in a new project. The Eastern Division
estimates that its return on investment (for all of its operations) would be at 22% with the new
investment.

3. Refer to Eastern Division. How much net segment income is the new project expected to produce?

ANS:
the total of the new segment income = .22($6,000,000+$1,000,000) =
.22($7,000,000) = $1,540,000

the portion of the total segment income that is produced by the new project =
$1,540,000 - $1,500,000 = $40,000

PTS: 1 DIF: Moderate OBJ: 14-4

4. Refer to Eastern Division. If the manager of the Eastern Division is evaluated on return on investment
alone, will the manager invest in the new project? Explain.

ANS:
The manager would not invest in the new project because the new project would lower the Division's
ROI from the current 25% ($1,500,000/$6,000,000) to 22%. The new project only generates an ROI of
4% ($40,000/$1,000,000)

PTS: 1 DIF: Moderate OBJ: 14-4

5. The manager of the Woodville Division of National Forest Tours is preparing the budget for the
upcoming year. At this point, he has determined that average total assets for the upcoming year will
equal $4,000,000. The manager is evaluated on the amount of residual income generated by the
division. Assume variable costs in the Woodville Division are expected to equal 60% of total sales and
fixed costs are expected to equal $400,000.

a. Compute the sales level that would generate a 20% return on investment.
b. Assuming the rate of return is 15%, determine the level of sales that would generate $200,000
of residual income.

ANS:
a. The required net income = 20% x $4,000,000 = $800,000.

sales = net income + fixed costs + variable costs

sales = $800,000 + $400,000 + (.60 x sales)
sales x 40% = $1,200,000
sales = $3,000,000

b. sales = fixed costs + variable costs + required return + residual income

sales = $400,000 + (.60 x sales) + (.15 x sales) + $200,000

sales = $2,400,000

PTS: 1 DIF: Moderate OBJ: 14-4

6. The following information is given for Apple and Banana Divisions of Fraternity Corporation.

Apple Banana
Sales $600,000 $300,000
Var. cost of goods sold 200,000 150,000
Fixed manufacturing costs 50,000 40,000
Variable selling 30,000 5,000
Fixed admin. (50% allocated) 20,000 4,000
Fixed selling (20% allocated) 50,000 30,000
Assets at book value 600,000 500,000

a. If Fraternity Corporation uses income to evaluate division managers, compute net income that
should be used for that purpose given the limited data above.
b. If Fraternity Corporation uses ROI to evaluate division managers and uses historical cost as the
investment base, compute the ROI for Apple and Banana.

ANS:

a. Apple Banana
Sales $600,000  $300,000 
CGS (250,000) (190,000)
Gross Margin $350,000  $110,000 
Variable selling (30,000) (5,000)
Fixed admin (10,000) (2,000)
Fixed selling (40,000) (24,000)
Controllable income $270,000  $ 79,000 

b. Apple Banana
$270,000 / $800,000 $79,000 / $600,000
 = 33.75% = 13.17%

PTS: 1 DIF: Moderate OBJ: 14-4

7. Information for two divisions of Wholesome Foods Company is given below:

Fruit Vegetable
Net income $ 60,000 $100,000
Capital investment $400,000 $500,000

a. If Wholesome Foods Company charges each division 12% for capital employed, compute
residual income for the Fruit and Vegetable divisions.
b. Compute the ROI for each division.

ANS:

a. Fruit Vegetable
Net income $60,000  $100,000 
Interest charge (48,000)  (60,000)
Residual income $12,000  $ 40,000 

b. ROI $60,000 / $400,000 $100,000 / $500,000

= 15% = 20%

PTS: 1 DIF: Moderate OBJ: 14-4

8. Integrated Furniture Systems (IFS), a division of Adams Corporation buys and installs modular office
components. For the most recent year, the division had the following performance targets:

Asset turnover 2.5

Profit margin 6%
Target rate of return on investments for RI 13%
Cost of capital 10%
Income tax rate 40%

Actual information concerning the company's performance for last year follows:

Total assets at beginning of year $3,600,000

Total assets at end of year 5,300,000
Total invested capital (annual average) 8,000,000
Sales 9,000,000
Variable operating costs 3,650,000
Direct fixed costs 4,770,000
Allocated fixed costs 675,000

Required:

a. For IFS, compute the segment margin and the average assets for the year.
b. Based on segment margin and average assets, compute the profit margin, asset turnover and
ROI.
c. Evaluate the ROI performance of IFS.
d. Using your answers from part b., compute the residual income of IFS.
 e. Compute the EVA of IFS. Why are the EVA and RI levels different?
f. Based on the data given in the problem, discuss why ROI, EVA and RI may be inappropriate
measures of performance for IFS.

ANS:

a. Sales $9,000,000 
Variable costs (3,650,000)
Direct fixed costs (4,770,000)
Segment margin $  580,000 

Average assets = ($3,600,000 + $5,300,000) / 2 = $4,450,000

b. Profit margin = $580,000 / $9,000,000 = 6.44%

Asset turnover = $9,000,000 / $4,450,000 = 2.02
ROI = $580,000 / $4,450,000 = 13%

c. The target ROI for the division was 2.5 x 6 = 15%. The division generated an ROI of only
13%. Thus the division did not achieve its target rate of return. The poor performance resulted
from the divisions failure to achieve its targeted asset turnover.

d. RI = $580,000 - (13% x $4,450,000)

= $580,000 - $578,500 = $1,500

e. After-tax profits = pretax income - taxes

= $580,000 - ($580,000 x 40%) = $348,000

EVA = $348,000 - ($8,000,000 x 10%) = $(452,000)

EVA and RI differ for three reasons. First, RI is based on pre-tax rather than after-tax income. Second,
RI is based on the book value of investment, whereas EVA is based on the market value of investment.
Third, the target rates of return differ between the methods.

f. ROI, RI and EVA are measures of short-term performance. These measures may be particularly
inappropriate for divisions that have long-term missions (such as high growth). In this case, the
relatively large growth and assets of IFS from the beginning of the period to the end of the
period may indicate this division is oriented to growth. If so, the ROI, RI and EVA measures
will provide an incentive contrary to the growth mission.

PTS: 1 DIF: Difficult OBJ: 14-4

9. The Cute Corporation produces small plastic dolls in its Florida manufacturing plant. The company is
currently evaluating ways to improve productivity. The accountant of the firm's parent organization
suggested that management implement a new compensation plan based on throughput performance
measure as an incentive to increase productivity. To demonstrate how such a measure might work, the
accountant gathered the following production data for a recent month:

Total units attempted 6,000,000

Good units manufactured 4,800,000
Processing time (total hours) 800
Value-added processing time 600
a. How many defective units were produced?
b. Compute manufacturing cycle efficiency.
c. Compute process productivity.
d. Compute process quality yield.
e. Compute hourly throughput.

ANS:

a. Defective units = 6,000,000 - 4,800,000 = 1,200,000

b. MCE = 600 / 800 = 75%
c. Process productivity = 6,000,000 / 600 = 10,000 units per hour
d. Process quality yield = 4,800,000 / 6,000,000 = 80%
e. Throughput = 10,000 x .75 x .8 = 6,000 dolls per hour

PTS: 1 DIF: Moderate OBJ: 14-7