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MULTIPLE CHOICE QUESTIONS

1. The biggest challenge in making a decentralized organization function effectively is:

A. earning maximum profits through fair practices.B. minimizing losses.C. taking advantage of the specialized knoledge and skills of highly talented managers.!. obtaining goal congruence among division managers.". developing an ade#uate budgetary control system.

Anser: ! $%: 1 Type: &C

'. (hat practice is present hen divisional managers throughout an organization ork togetherin an effort to achieve the organization)s goals*A. +articipatory management.B. ,oal attainment.

C. ,oal congruence.!. Centralization of ob-ectives.". egotiation by subordinates.

Anser: C $%: 1 Type: &C

/. Consider the folloing statements about goal congruence:

0. ,oal congruence is obtained hen managers of subunits throughout an organizationstrive to achieve the goals set by top management.

00. anagers are often more concerned about the performance of their on subunitsrather than the performance of the entire organization.

000. Achieving goal congruence in most organizations is relatively straightforard andeasy to accomplish.

(hich of the above statements is 2are3 true*A. 0 only.B. 00 only.C. 0 and 00.!. 00 and 000.". 04 004 and 000.

Anser: C $%: 1 Type: &C

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5. (hich of the folloing performance measures is 2are3 used to evaluate the financial success or failure of investment centers*A. &esidual income.B. &eturn on investment.

C. umber of suppliers.!. "conomic value added.". All of the above measures are used except 6C.6

Anser: " $%: 1 Type: &C

7. &%0 is most appropriately used to evaluate the performance of:A. cost center managers.B. revenue center managers.C. profit center managers.!. investment center managers.". both profit center managers and investment center managers.

Anser: ! $%: ' Type: &C

8. (hich of the folloing is not considered in the calculation of divisional &%0*A. !ivisional income.B. "arnings velocity.C. Capital turnover.!. 9ales margin.". 9ales revenue.

Anser: B $%: ' Type: &C

. (hich of the folloing is the correct mathematical expression for return on investment*A. 9ales margin ; capital turnover.B. 9ales margin < capital turnover.C. 9ales margin = capital turnover.!. 9ales margin x capital turnover.". Capital turnover ; sales margin.


>. The &%0 calculation ill indicate:A. the percentage of each sales dollar that is invested in assets.B. the sales dollars generated from each dollar of income.

C. ho effectively a company used its invested capital.!. the invested capital generated from each dollar of income.". the overall #uality of a company)s earnings.

Anser: C $%: ' Type: &C

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?. A company)s sales margin:A. must4 by definition4 be greater than the firm)s net sales.B. has basically the same meaning as the term 6contribution margin.6C. is computed by dividing sales revenue into income.

!. is computed by dividing income into sales revenue.". shos the sales dollars generated from each dollar of income.


1@. (hich of the folloing is the correct mathematical expression to derive a company)s capitalturnover*A. 9ales revenue ; invested capital.B. Contribution margin ; invested capital.C. 0ncome ; invested capital.!. 0nvested capital ; sales revenue". 0nvested capital ; income

Anser: A $%: ' Type: &C

11. Capital turnover shos:A. the amount of income generated by each dollar of capital investment.B. the number of sales dollars generated by each dollar of capital investment.C. the amount of contribution margin generated by each dollar of capital investment.!. the amount of capital investment generated by each sales dollar.". the amount of capital investment generated by each dollar of income.

Anser: B $%: ' Type: &C

1'. (ebster Company had sales revenue and operating expenses of 74@@@4@@@ and 54'@@4@@@4respectively4 for the year -ust ended. 0f invested capital amounted to 84@@@4@@@4 the firm)s&%0 as:A. 1/.//.B. >/.//.C. 1'@.@@.!. 7@.@@.". some other figure.

Anser: A $%: ' Type: A

1/. ang "nterprises had a sales margin of 4 sales of 74@@@4@@@4 and invested capital of

54@@@4@@@. The company)s &%0 as:A. [email protected]. >.7.C. 11.5/.!. 1.>8.". some other figure.

Anser: B $%: ' Type: A

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15. ission4 0nc.4 reported a return on investment of 1'4 a capital turnover of 74 and income of1>@4@@@. %n the basis of this information4 the company)s invested capital as:A. /@@4@@@.B. ?@@4@@@.

C. 147@@4@@@.!. 47@@4@@@.". some other amount.

Anser: C $%: ' Type: A

17. The information that follos relates to Datz Corporation:

9ales margin: .7Capital turnover: '0nvested capital: '@4@@@4@@@

%n the basis of this information4 the company)s sales revenue is:A. 147@@4@@@.B. /4@@@4@@@.C. 1@4@@@4@@@.!. 5@4@@@4@@@.". some other amount.

Anser: ! $%: ' Type: A

18. A division)s return on investment may be improved by increasing:A. cost of goods sold and expenses.B. sales margin and cost of capital.

C. sales revenue and cost of capital.!. capital turnover or sales margin.". capital turnover or cost of capital.

Anser: ! $%: / Type: &C

1. All of the folloing actions ill increase &%0 except:A. an increase in sales revenues.B. a decrease in operating expenses.C. a decrease in a company)s invested capital.!. a decrease in the number of units sold.". an improvement in manufacturing efficiency.

Anser: ! $%: / Type:


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1>. (hich of the folloing is used in the calculation of both return on investment and residualincome*A. Total stockholders) e#uity.B. &etained earnings.

C. 0nvested capital.!. Total liabilities.". The cost of capital.


1?. Consider the folloing statements about residual income:

0. &esidual income incorporates a firm)s cost of ac#uiring investment capital.00. &esidual income is a percentage measure4 not a dollar measure.000. 0f used correctly4 residual income may result in division managers making decisions

that are in their on best interest and not in the best interest of the entire firm.

(hich of the above statements is 2are3 true*A. 0 only.B. 00 only.C. 0 and 00.!. 00 and 000.". 0 and 000.

Anser: A $%: '4 5 Type: &C

'@. The basic idea behind residual income is to have a division maximize its:A. earnings per share.

B. income in excess of a corporate imputed interest charge.C. cost of capital.!. cash flos.". invested capital.

Anser: B $%: '4 5 Type:

'1. 9unrise Corporation has a return on investment of 17. A 9unrise division4 hich currentlyhas a 1/ &%0 and 7@4@@@ of residual income4 is contemplating a massive ne investmentthat ill 213 reduce divisional &%0 and 2'3 produce 1'@4@@@ of residual income. 0f 9unrisestrives for goal congruence4 the investment:A. should not be ac#uired because it reduces divisional &%0.

B. should not be ac#uired because it produces 1'@4@@@ of residual income.C. should not be ac#uired because the division)s &%0 is less than the corporate &%0 beforethe investment is considered.

!. should be ac#uired because it produces 1'@4@@@ of residual income for the division.". should be ac#uired because after the ac#uisition4 the division)s &%0 and residual income

are both positive numbers.

Anser: ! $%: 5 Type:

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''. The Eitzhugh !ivision of ,eneral "nterprises has a negative residual income of 75@4@@@.Eitzhugh)s management is contemplating an investment opportunity that ill reduce thisnegative amount to 5@@4@@@. The investment:A. should be pursued because it is attractive from both the divisional and corporate

perspectives.B. should be pursued because it is attractive from the divisional perspective although not

from the corporate perspective.C. should be pursued because it is attractive from the corporate perspective although not

from the divisional perspective.!. should not be pursued because it is unattractive from both the divisional and corporate

perspectives.". should not be pursued because it is unattractive from the divisional perspective although it

is attractive from the corporate perspective.

Anser: A $%: 5 Type:

'/. The agellan !ivision of ,lobal Corporation4 hich has income of '7@4@@@ and an assetinvestment of 1478'47@@4 is studying an investment opportunity that ill cost 57@4@@@ andyield a profit of 847@@. Assuming that ,lobal uses an imputed interest charge of 154ould the investment be attractive to:

1F!ivisional management if &%0 is used to evaluate divisional performance*'F!ivisional management if residual income 2&03 is used to evaluate divisional

performance*/FThe management of ,lobal Corporation*

Attractive toagellan: &%0

Attractive toagellan: &0

Attractiveto ,lobal

A. Ges Ges GesB. Ges o oC. Ges o Ges!. o Ges Ges". o Ges o

Anser: ! $%: 5 Type: A4

'5. The ,eorgia !ivision of Carter Companies currently reports a profit of /.5 million.!ivisional invested capital totals 1'.7 millionH the imputed interest rate is 15. %n the basisof this information4 ,eorgia)s residual income is:A. 584@@@.

B. 14'54@@@.C. 1487@4@@@.!. 147@4@@@.". some other amount.



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'7. The folloing information relates to the ountain !ivision of Adler "nterprises:

0ncome for the period -ust ended: 147@@4@@@0nvested capital: 1'4@@@4@@@

0f the firm has an imputed interest rate of 114 ountain)s residual income ould be:A. 1874@@@.B. 1>@4@@@.C. 1>47@@.!. some other dollar amount.". a percentage greater than 11.


'8. "xtron !ivision reported a residual income of '@@4@@@ for the year -ust ended. The divisionhad >4@@@4@@@ of invested capital and 14@@@4@@@ of income. %n the basis of this

information4 the imputed interest rate as:A. '.7.B. 1@[email protected]. 1'.7.!. '@.@.". some other figure.


'. Barber Corporation uses an imputed interest rate of 1/ in the calculation of residual income.!ivision I4 hich is part of Barber4 had invested capital of 14'@@4@@@ and an &%0 of 18.%n the basis of this information4 I)s residual income as:

A. '[email protected]. /84@@@.C. 1784@@@.!. 1?'4@@@.". some other amount.

Anser: B $%: ' Type: A4

Jse the folloing to anser #uestions '>=/1:

The folloing information pertains to Bingo Concrete:

9ales revenue 147@@4@@@,ross margin 8@@4@@@0ncome ?@4@@@0nvested capital 57@4@@@

The company)s imputed interest rate is >.

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'>. The capital turnover is:A. /.//.B. 7.@@.C. 18.8.

!. '@.@@.". /@.@@.


'?. The sales margin is:A. 8.B. 17.C. '@.!. /@.". 5@.


/@. The &%0 is:A. 8.B. 17.C. '@.!. /@.". 5@.


/1. The residual income is:

A. /@4@@@.B. /84@@@.C. 5'4@@@.!. 754@@@.". >'4>@@.


/'. Eor the period -ust ended4 Jnited Corporation)s !elta !ivision reported profit of /1.? millionand invested capital of ''@ million. Assuming an imputed interest rate of 1'4 hich of thefolloing choices correctly denotes !elta)s return on investment 2&%03 and residual income*

&eturn on

0nvestment

&esidual

0ncomeA. 1'.@ 27.73 millionB. 1'.@ 7.7 millionC. 15.7 27.73 million!. 15.7 7.7 million". 15.7 '8.5 million



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//. Eor the period -ust ended4 +rice Corporation)s %hio !ivision reported profit of 5? million andinvested capital of /7@ million. Assuming an imputed interest rate of 184 hich of thefolloing choices correctly denotes %hio)s return on investment 2&%03 and residual income*

&eturn on

0nvestment

&esidual

0ncomeA. 15 millionB. 15 23 millionC. 18 million!. million 15". one of the above choices shos both the correct &%0 and residual income.


/5. (hich of the folloing elements is not used hen calculating the eighted=average cost ofcapital*A. Before=tax cost of debt capital.

B. After=tax cost of debt capital.C. Cost of e#uity capital.!. arket value of debt capital.". arket value of e#uity capital.

Anser: A $%: ' Type: &C

/7. The folloing information relates to the Atlantic !ivision of %cean "nterprises:

0nterest rate on debt capital: >Cost of e#uity capital: 1'arket value of debt capital: 7@ million

arket value of e#uity capital: >@ million0ncome tax rate: /@

%n the basis of this information4 Atlantic)s eighted=average cost of capital is:A. ./.B. >./.C. ?.7.!. 1@.>.". some other figure.


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/8. The market value of ,lendaleKs debt and e#uity capital totals 1>@ million4 >@ of hich is

e#uity related. An analysis conducted by the companyKs finance department revealed a after=tax cost of debt capital and a 1@ cost of e#uity capital. %n the basis of thisinformation4 ,lendaleKs eighted=average cost of capital:

A. is .8.B. is >.7.C. is ?.5.!. cannot be determined based on the data presented because the cost of debt capital must be

stated on a before=tax basis.". cannot be determined based on the data presented because the cost of e#uity capital must

be stated on an after=tax basis.

Anser: C $%: ' Type: A4

/. (hich of the folloing measures of performance is4 in part4 based on the eighted=average cost of capital*A. &eturn on investment.B. Capital turnover.C. Book value.!. "conomic value added 2"LA3.". ,ross margin.


/>. (hich of the folloing elements is not used in the calculation of economic valueadded for an investment center*A. An investment center)s after=tax operating income.

B. An investment center)s total assets.C. An investment center)s return on investment.!. An investment center)s current liabilities.". A company)s eighted=average cost of capital.


/?. Carolina Corporation has an after=tax operating income of /4'@@4@@@ and a ? eighted=average cost of capital. Assets total 4@@@4@@@ and current liabilities total 14>@@4@@@. %nthe basis of this information4 Carolina)s economic value added is:A. '45@>4@@@.

B. '4/'4@@@.C. /488>4@@@.!. /4??'4@@@.". some other amount.


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5@. The folloing information relates to Mouston4 0nc.:

Total assets ?4@@@4@@@After=tax operating income 147@@4@@@

Current liabilities >@@4@@@

0f the company has a 1@ eighted=average cost of capital4 its economic value added ould be:A. 2'@@4@@@3.B. 7/@4@@@.C. 8>@4@@@.!. ?@4@@@.". some other amount.


51. ,iven that &%0 measures performance over a period of time4 invested capital ould mostappropriately be figured by using:A. beginning=of=year assets.B. average assets.C. end=of=year assets.!. total assets.". only current assets.

Anser: B $%: 7 Type: &C

5'. (hen an organization allos divisional managers to be responsible for short=term loans andcredit4 the division)s invested capital should be measured by

A. total assets minus total liabilities.B. average total assets minus average current liabilities.C. average total assets minus average total liabilities.!. average total liabilities minus average current assets.". average total liabilities minus total assets.


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5/. Mayes !ivision has been stagnant over the past five years4 neither groing nor contracting insize and profitability. 0nvestments in ne property4 plant4 and e#uipment have been minimal.(ould the division)s use of total assets 2valued at net book value3 hen measuring &%0 resultin 213 using numbers that are consistent ith those on the balance sheet and 2'3 a rising &%0

over time*Consistent ith umbers on the Balance 9heet*

+roduce a &ising &eturn on0nvestment %ver Time*

A. Ges GesB. Ges oC. o Ges!. o o". Ges eed more information

to -udge

Anser: A $%: 7 Type: &C

55. The income calculation for a division manager)s &%0 should be based on:A. divisional contribution margin.B. profit margin controllable by the division manager.C. profit margin traceable to the division.!. divisional income before interest and taxes.". divisional net income.


57. To partially eliminate the problems that are associated ith the short=term focus of return oninvestment4 residual income4 and "LA4 the performance of a division)s ma-or investments iscommonly evaluated through:

A. postaudits.B. sensitivity analysis.C. performance operating plans.!. horizontal analysis.". segmented reporting.


58. The amounts charged for goods and services exchanged beteen to divisions are knon as:A. opportunity costs.B. transfer prices.C. standard variable costs.

!. residual prices.". target prices.



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5. evada4 0nc.4 has to divisions4 one located in $as Legas and the other located in &eno. $asLegas sells selected goods to &eno for use in various end=products. Assuming that the transfer prices set by $as Legas do not influence the decisions made by the to divisions4 hich of thefolloing correctly describes the impact of the transfer prices on divisional profits and overall

company profit*$as Legas +rofit &eno +rofit evada +rofit

A. Affected Affected AffectedB. Affected Affected ot affectedC. Affected ot affected Affected!. ot affected ot affected Affected". ot affected ot affected ot affected


5>. Thurmond4 0nc.4 has to divisions4 one located in e Gork and the other located in Arizona. e Gork sells a specialized circuit to Arizona and -ust recently raised the circuitKs transfer

price. This price hike had no effect on the volume of circuits transferred nor on ArizonaKsoption of ac#uiring the circuit from either e Gork or from an external supplier. %n the basis of this information4 hich of the folloing statements is most correct*A. The profit reported by e Gork ill increase and the profit reported by Arizona ill

decrease.B. The profit reported by e Gork ill increase4 the profit reported by Arizona ill

decrease4 and ThurmondKs profit ill be unaffected.C. The profit reported by e Gork ill decrease4 the profit reported by Arizona ill

increase4 and ThurmondKs profit ill be unaffected.!. The profit reported by e Gork ill increase and the profit reported by Arizona ill

increase.". The profit reported by e Gork and the profit reported by Arizona ill be

unaffected.

Anser: B $%: 8 Type: &C4

5?. (hich of the folloing describes the goal that should be pursued hen setting transfer prices*A. aximize profits of the buying division.B. aximize profits of the selling division.C. Allo top management to become actively involved hen calculating the proper dollar

amounts.!. "stablish incentives for autonomous division managers to make decisions that are in the

overall organization)s best interests 2i.e.4 goal congruence3.". inimize opportunity costs.


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7@. A general calculation method for transfer prices that achieves goal congruence begins ith theadditional outlay cost per unit incurred because goods are transformed and thenA. adds the opportunity cost per unit to the organization because of the transfer.B. subtracts the opportunity cost per unit to the organization because of the transfer.

C. adds the sunk cost per unit to the organization because of the transfer.!. subtracts the sunk cost per unit to the organization because of the transfer.". adds the sales revenue per unit to the organization because of the transfer.


71. 9uddath Corporation has no excess capacity. 0f the firm desires to implement the generaltransfer=pricing rule4 opportunity cost ould be e#ual to:A. zero.B. the direct expenses incurred in producing the goods.C. the total difference in the cost of production beteen to divisions.!. the contribution margin forgone from the lost external sale.

". the summation of variable cost plus fixed cost.


7'. Tulsa Corporation has excess capacity. 0f the firm desires to implement the general transfer= pricing rule4 opportunity cost ould be e#ual to:A. zero.B. the direct expenses incurred in producing the goods.C. the total difference in the cost of production beteen to divisions.!. the contribution margin forgone from the lost external sale.". the summation of variable cost plus fixed cost.


7/. cDenna)s Elorida !ivision is currently purchasing a part from an outside supplier. Thecompany)s Alabama !ivision4 hich has excess capacity4 makes and sells this part for externalcustomers at a variable cost of '' and a selling price of /5. 0f Alabama begins sales toElorida4 it 213 ill use the general transfer=pricing rule and 2'3 ill be able to reduce variablecost on internal transfers by 5. 0f sales to outsiders ill not be affected4 Alabama ouldestablish a transfer price of:A. 1>.B. ''.C. /@.!. /5.

". some other amount.

Anser: A $%: 8 Type: A


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75. AutoTech)s orthern !ivision is currently purchasing a part from an outside supplier. Thecompany)s 9outhern !ivision4 hich has no excess capacity4 makes and sells this part forexternal customers at a variable cost of 1? and a selling price of /1. 0f 9outhern beginssales to orthern4 it 213 ill use the general transfer=pricing rule and 2'3 ill be able to reduce

variable cost on internal transfers by /. %n the basis of this information4 9outhern ouldestablish a transfer price of:A. 18.B. 1?.C. '>.!. /1.". some other amount.

Anser: C $%: 8 Type: A

Jse the folloing to anser #uestions 77=7:

$aissez Eaire has to divisions: the Cologne !ivision and the Bottle !ivision. The Bottle !ivision produces containers that can be used by the Cologne !ivision. The Bottle !ivision)s variablemanufacturing cost is '4 shipping cost is @.1@4 and the external sales price is /. o shipping costsare incurred on sales to the Cologne !ivision4 and the Cologne !ivision can purchase similarcontainers in the external market for '.8@.

77. The Bottle !ivision has sufficient capacity to meet all external market demands in addition tomeeting the demands of the Cologne !ivision. Jsing the general rule4 the transfer price fromthe Bottle !ivision to the Cologne !ivision ould be:A. '.@@.B. '[email protected]. '.8@.

!. '.?@.". /.@@.

Anser: A $%: 8 Type: A

78. Assume the Bottle !ivision has no excess capacity and could sell everything it producedexternally. Jsing the general rule4 the transfer price from the Bottle !ivision to the Cologne!ivision ould be:A. '.@@.B. '[email protected]. '.8@.!. '.?@.

". /.@@.

Anser: ! $%: 8 Type: A

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7. The maximum amount the Cologne !ivision ould be illing to pay for each bottletransferred ould be:A. '.@@.B. '.1@.

C. '.8@.!. '.?@.". /.@@.

Anser: C $%: 8 Type: A

7>. Transfer prices can be based on:A. variable cost.B. full cost.C. an external market price.!. a negotiated settlement beteen the buying and selling divisions.". all of the above.

Anser: " $%: Type: &C

7?. (hich of the folloing transfer=pricing methods can lead to dysfunctional decision=making behavior by managers*A. Lariable cost.B. Eull cost.C. "xternal market price.!. A professionally negotiated4 amicable settlement beteen the buying and selling

divisions.". one of the above.

Anser: B $%: Type: &C

8@. The +ro !ivision of Custom 0ndustries is in need of a particular service. The service can beobtained from another division of Custom at 6cost46 ith cost defined as the summation ofvariable cost 2?3 and fixed cost 2/3. Alternatively4 +ro can secure the service from a sourceexternal to Custom for 1@. (hich of the folloing statements is true*A. +ro should compare 1@ vs. / in deciding here to ac#uire the service.B. +ro should compare 1@ vs. ? in deciding here to ac#uire the service.C. +ro should compare 1@ vs. 1' in deciding here to ac#uire the service.!. Erom Custom)s perspective4 the proper decision is reached by comparing 1@ vs. ?.". Both 6C6 and 6!6 are true.

Anser: " $%: Type: A4


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81. !ivision A transfers item no. > to !ivision B. Consider the folloing situations:

1FA is located in Texas and B is located in California.'FA is located in Texas and B is located in exico.

Assuming that item no. > is unavailable in the open market4 hich of the folloing choicescorrectly depicts the probable importance of federal income taxes hen determining thetransfer price that is established for item no. >*

9ituation 1 9ituation '

A. 0mportant 0mportantB. 0mportant ot importantC. ot important 0mportant

!. ot important ot important". 0t is not possible to -udge based on the information presented.

Anser: C $%: Type:

8'. !ivision A transfers a profitable subassembly to !ivision B4 here it is assembled into a final product. A is located in a "uropean country that has a high tax rateH B is located in an Asiancountry that has a lo tax rate. 0deally4 213 hat type of before=tax income should eachdivision report from the transfer and 2'3 hat type of transfer price should be set for thesubassembly*

!ivision A0ncome

!ivision B0ncome

Transfer +rice

A. $o $o $oB. $o Migh $oC. $o Migh Migh!. Migh $o Migh

". Migh Migh $o

Anser: B $%: Type:

8/. Consider the folloing statements about transfer pricing:

0. 0ncome taxes and import duties are an important consideration hen setting a transfer price for companies that pursue international commerce.

00. Transfer prices cannot be used by organizations in the service industry.000. Transfer prices are totally cost=based in nature4 not market=based.

(hich of the above statements is 2are3 true*

A. 0 only.B. 00 only.C. 0 and 00.!. 00 and 000.". 04 004 and 000.

Anser: A $%: Type: &C

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EXERCISES

Components of Return on Investment

85. The folloing data pertain to Corkscre Corporation:

0ncome >4@@@4@@@9ales revenue 5@4@@@4@@@Average invested capital 7@4@@@4@@@

&e#uired:Calculate Corkscre Corporation)s sales margin4 capital turnover4 and return on investment.

$%: ' Type: A

Anser:9ales margin: >4@@@4@@@ ; 5@4@@@4@@@ N '@

Capital turnover: 5@4@@@4@@@ ; 7@4@@@4@@@ N @.>&eturn on investment: >4@@@4@@@ ; 7@4@@@4@@@ N 18

Components of ROI and Residual Inome! "or#in$ %a#&ard

87. idland !ivision4 hich is part of Courtyard "nterprises4 recently reported a sales margin of/@4 &%0 of '14 and residual income of ''@4@@@. Courtyard uses an imputed interest rateof 1@.

&e#uired:A. Briefly define sales margin4 capital turnover4 and return on investment.B. Compute idland)s capital turnover and invested capital.

C. 0gnoring your ork in re#uirement 6B46 assume that invested capital amounted to'47@@4@@@. %n the basis of this information4 calculate idland)s income and salesrevenue.

$%: ' Type: A4


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Anser:A. 9ales marginFthe income generated from each sales dollar.

Computed as: 0ncome ; sales revenue.

Capital turnoverFthe sales dollars produced from each dollar of invested capital.Computed as: 9ales revenue ; invested capital.

&eturn on investmentFthe income generated from each dollar of invested capital.Computed as: 0ncome ; invested capital4 or sales margin x capital turnover.

B. Capital turnover:Capital turnover x sales margin N &%0Capital turnover x /@ N '1Capital turnover N @.

0nvested capital:

&%0 N 0ncome ; invested capital'1 N 0ncome ; invested capital0ncome N 0nvested capital x '1

&esidual income N 0ncome = 2invested capital x imputed interest rate3''@4@@@ N 0ncome = 2invested capital x 1@3''@4@@@ N 20nvested capital x '13 = 2invested capital x 1@3''@4@@@ N 0nvested capital x 110nvested capital N '4@@@4@@@

C. 0ncome:&%0 N 0ncome ; invested capital

'1 N 0ncome ; '47@@4@@@0ncome N 7'74@@@

9ales revenue:9ales margin N 0ncome ; sales revenue/@ N 7'74@@@ ; sales revenue9ales revenue N 147@4@@@

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Eonomi 'alue (dded) "ei$*ted+(vera$e Cost of Capital

88. The folloing data pertain to !ana 0ndustries:

0nterest rate on debt capital: ?Cost of e#uity capital: 1'Before=tax operating income: /7 millionarket value of debt capital: 8@ millionarket value of e#uity capital: 1'@ millionTotal assets: 17@ million0ncome tax rate: /@Total current liabilities: 17 million

&e#uired:A. Compute !anaKs eighted=average cost of capital.B. Compute !anaKs economic value added.

C. Briefly explain the meaning of economic value added.

$%: ' Type: &C4 A

Anser:A. (ACC N O2? x @3 x 8@4@@@4@@@3 < 21' x 1'@4@@@4@@@3P ; 28@4@@@4@@@ <

1'@4@@@4@@@3(ACC N 2/4>@4@@@ < 1545@@4@@@3 ; 1>@4@@@4@@@(ACC N [email protected]

B. "LA N 2/74@@@4@@@ x @3 = O217@4@@@4@@@ = 174@@@4@@@3

x [email protected]"LA N '547@@4@@@ = 1/48/74@@@"LA N 1@4>874@@@

C. "conomic value added 2"LA3 measures the amount of shareholder ealth being createdfrom a companyKs activities and operations. To expand4 debt and e#uity capital are used tofund activitiesFactivities that are hopefully conducted in a profitable manner. +rofitscover the cost of the related capital4 ith shareholders benefiting from the residual 2i.e.4

!. "LA3.


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Improvin$ Return on Investment

8. The folloing data pertain to orris Company for '@x1:

9ales revenue 14@@@4@@@Cost of goods sold 77@4@@@%perating expenses 5@@4@@@Average invested capital 7@@4@@@

&e#uired:A. Calculate the company)s sales margin4 capital turnover4 and return on investment for '@x1.B. 0f the sales and average invested capital remain the same4 to hat level ould total costs

and expenses have to be reduced in '@x' to achieve a 17 return on investment*C. Assume that costs and expenses are reduced4 as calculated in re#uirement 6B.6 Calculate

the firm)s ne sales margin.!. 9uggest to possible actions that ill improve the company)s capital turnover.

$%: '4 / Type: A4

Anser:A. 9ales revenue 14@@@4@@@

$ess: Cost of goods sold 77@4@@@%perating expenses 5@@4@@@ ?7@4@@@

%perating income 7@4@@@

9ales margin: 7@4@@@ ; 14@@@4@@@ N 7Capital turnover: 14@@@4@@@ ; 7@@4@@@ N '&eturn on investment: 7@4@@@ ; 7@@4@@@ N 1@

B. e income level: 7@@4@@@ x 17 N 74@@@

9ales revenue 14@@@4@@@$ess: 0ncome 74@@@Costs and expenses ?'74@@@

Therefore4 total costs and expenses must be reduced from ?7@4@@@ 277@4@@@ <5@@4@@@3 to ?'74@@@ in order to achieve a 17 &%0.

C. 9ales margin: 74@@@ ; 14@@@4@@@ N .7

!. Capital turnover can be improved by increasing sales revenue and reducing investedcapital.

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Return on Investment and Residual Inome! Calulation and (nal,sis

8>. The folloing data pertain to the %xnard !ivision of Demp Company:

!ivisional contribution margin @@4@@@+rofit margin controllable by the divisional manager /'@4@@@+rofit margin traceable to the division '?545@@Average asset investment 14'>@4@@@

The company uses responsibility accounting concepts hen evaluating performance4 and%xnard)s division manager is contemplating the folloing three investments. Me can invest upto 5@@4@@@.

o. 1 o. ' o. /Cost '7@4@@@ /@@4@@@ 5@@4@@@"xpected income 7@4@@@ 754@@@ ?84@@@

&e#uired:A. Calculate the &%0s of the three investments.B. (hat is the division manager)s current &%04 computed by using responsibility accounting

concepts*C. (hich of the three investments ould be selected if the manager)s focus is on %xnard)s

divisional performance* (hy*!. 0f Demp has an imputed interest charge of ''4 compute the residual income of

investment no. /. 0s this investment attractive from %xnard)s perspective* Erom Demp)s perspective* (hy*

$%: '4 5 Type: A4

Anser:A. o. 1: 7@4@@@ ; '7@4@@@ N '@

o. ': 754@@@ ; /@@4@@@ N 1> o. /: ?84@@@ ; 5@@4@@@ N '5

B. Controllable profit margin 2/'@4@@@3 ; asset investment 214'>@4@@@3 N '7

C. one4 as all ill loer the current &%0.

!. &esidual income: ?84@@@ = 25@@4@@@ x ''3 N >4@@@

This investment is attractive from both %xnard and Demp)s perspectives. The positiveresidual income indicates that the investment income covers the imputed interestcharge.


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ROI and Residual Inome) Investment Evaluation

8?. Qasper Corporation is organized in three separate divisions. The three divisional managers areevaluated at year=end4 and bonuses are aarded based on &%0. $ast year4 the overall company

produced a 1' return on its investment.

anagers of Qasper)s 0oa !ivision recently studied an investment opportunity that ouldassist in the division)s future groth. &elevant data follo.

0oa!ivision

0nvestment%pportunity

0ncome 1'4>@@4@@@ 54'@@4@@@0nvested capital >@4@@@4@@@ /@4@@@4@@@

&e#uired:A. Compute the current &%0 of the 0oa !ivision and the division)s &%0 if the investment

opportunity is pursued.B. (hat is the likely reaction of divisional management toard the ac#uisition* (hy*C. (hat is the likely reaction of Qasper)s corporate management toard the investment*

(hy*!. Assume that Qasper uses residual income to evaluate performance and desires an 11

minimum return on invested capital. Compute the current residual income of the 0oa!ivision and the division)s residual income if the investment is made. (ill divisionalmanagement likely change its attitude toard the ac#uisition* (hy*

$%: '4 5 Type: A4

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Anser:A. &%0 N 0ncome ; invested capital

Current: 1'4>@@4@@@ ; >@4@@@4@@@ N 180f investment is made: 21'4>@@4@@@ < 54'@@4@@@3 ; 2>@4@@@4@@@ < /@4@@@4@@@3 N

17.57

B. !ivisional management ill likely be against the ac#uisition because &%0 ill be loeredfrom 18 to 17.57. 9ince bonuses are aarded on the basis of &%04 the ac#uisition illresult in less compensation. Moever4 before a final decision is made4 additional insightsare needed concerning ho the investment ill assist in future groth and in hatmagnitude.

C. An examination of the investment reveals a 15 &%0 254'@@4@@@ ; /@4@@@4@@@3.Corporate management ould probably favor the ac#uisition. Qasper has been earning a1' return4 and the investment ill help the organization as a hole.

!. Current residual income of 0oa !ivision:!ivisional income 1'4>@@4@@@$ess: 0mputed interest charge 2>@4@@@4@@@ x 113 >4>@@4@@@&esidual income 54@@@4@@@

&esidual income if investment is made:!ivisional income 21'4>@@4@@@ < 54'@@4@@@3 14@@@4@@@$ess: 0mputed interest charge O2>@4@@@4@@@ < /@4@@@4@@@3 x 11P 1'41@@4@@@&esidual income 54?@@4@@@

Ges4 divisional managers ill likely change their attitude4 particularly if they are team players. &esidual income ill increase by ?@@4@@@ 254?@@4@@@ = 54@@@4@@@3 from the

ac#uisition. The &0 measure focuses on the corporate perspective4 not the divisional perspective4 by integrating the firm)s re#uired return on invested capital.


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Usin$ ROI and Residual Inome in Operatin$ -eisions

@. !eborah $eis4 general manager of the orthest !ivision of Berkshire "nterprises4 hassignificant authority over pricing decisions as ell as programs that involve cost

reductionRcontrol. The data that follo relate to upcoming divisional operations:

Average invested capital: 174@@@4@@@Annual fixed costs: /4?@@4@@@Lariable cost per unit: >@ umber of units expected to be sold: 1'@4@@@

&e#uired:A. Top management ill promote !eborah if she can earn a 15 return on investment for the

year. (hat unit selling price should she establish to get her promotion*B. 0ndependent of part 6A46 assume the unit selling price is 1/' and that Berkshire has a

18 imputed interest charge. Top management ill promote !eborah to corporate

head#uarters if her division can generate '@@4@@@ of residual income. 0f !eborah desiresto move to corporate4 hat must the division do to the amount of annual fixed costsincurred* 9ho your calculations.

$%: '4 5 Type: A4

Anser:A. A 15 return on investment ill re#uire the !ivision to produce income of '41@@4@@@

2174@@@4@@@ x 153. 0f I N selling price4 then:1'@4@@@I = 21'@4@@@ x >@3 = /4?@@4@@@ N '41@@4@@@1'@4@@@I = ?48@@4@@@ = /4?@@4@@@ N '41@@4@@@1'@4@@@I N 1748@@4@@@

I N 1/@

B. 0f I N fixed cost4 then:O21/' = >@3 x 1'@4@@@P = I = 2174@@@4@@@ x 183 N '@@4@@@84'5@4@@@ = I = '45@@4@@@ N '@@4@@@I N /485@4@@@

To achieve her promotion4 !eborah must reduce fixed costs by '8@4@@@ 2/4?@@4@@@ =/485@4@@@3.

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%asi Transfer Priin$! .eneral Rule

1. Bronx Corporation)s ,auge !ivision manufactures and sells product no. '54 hich is used inrefrigeration systems. +er=unit variable manufacturing and selling costs amount to '@ and

74 respectively. The !ivision can sell this item to external domestic customers for /8 or4alternatively4 transfer the product to the company)s &efrigeration !ivision. &efrigeration iscurrently purchasing a similar unit from Taian for //. Assume use of the general transfer= pricing rule.

&e#uired:A. (hat is the most that the &efrigeration !ivision ould be illing to pay the ,auge

!ivision for one unit*B. 0f ,auge had excess capacity4 hat transfer price ould the !ivision)s management set*C. 0f ,auge had no excess capacity4 hat transfer price ould the !ivision)s management

set*!. &epeat part 6C46 assuming that ,auge as able to reduce the variable cost of internal

transfers by 5 per unit.

$%: 8 Type: A

Anser:A. &efrigeration ould be illing to pay a maximum of //4 its current outside purchase

price.

B. The general rule holds that the transfer price be set at the sum of outlay cost andopportunity cost. Thus4 2'@ < 73 < @ N '7.

C. 0n this case4 the transfer price ould amount to /8: 2'@ < 73 < 2/8 = '@ = 73.

!. The transfer price ould be /': 2'@ < 7 = 53 < 2/8 = '@ = 73.


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%asi Transfer Priin$

'. ,amma !ivision of Laughn Corporation produces electric motors4 '@ of hich are sold toLaughan)s %mega !ivision and >@ to outside customers. Laughn treats its divisions as

profit centers and allos division managers to choose hether to sell to or buy from internaldivisions. Corporate policy re#uires that all interdivisional sales and purchases be transferredat variable cost. ,amma !ivision)s estimated sales and standard cost data for the year ended!ecember /14 based on a capacity of 8@4@@@ units4 are as follos:

%mega %utsiders9ales 88@4@@@ 748@4@@@$ess: Lariable costs 88@4@@@ '485@4@@@Contribution margin ==== /41'@4@@@$ess: Eixed costs 174@@@ ?@@4@@@%perating income 2loss3 2174@@@3 '4''@4@@@

Jnit sales 1'4@@@ 5>4@@@

,amma has an opportunity to sell the 1'4@@@ units shon above to an outside customer at >@ per unit. %mega can purchase the units it needs from an outside supplier for ?' each.

&e#uired:A. Assuming that ,amma desires to maximize operating income4 should it take on the ne

customer and discontinue sales to %mega* (hy* 2ote: Anser this #uestion from,amma)s perspective.3

B. Assume that Laughn allos division managers to negotiate transfer prices. The managersagreed on a tentative price of >@ per unit4 to be reduced by an e#ual sharing of theadditional ,amma income that results from the sale to %mega of 1'4@@@ motors at >@ per

unit. %n the basis of this information4 compute the company)s ne transfer price.

$%: 84 Type: A

Anser:A. Ges. ,amma is currently selling motors to %mega at a transfer price of 77 per unit

288@4@@@ ; 1'4@@@ units3. A price of >@ to the ne customer ill increase ,amma!ivision)s operating income by /@@4@@@ O2>@ = 773 x 1'4@@@ unitsP.

B. The additional operating income to ,amma is /@@4@@@ O2>@ = 773 x 1'4@@@ unitsP.9plitting this amount e#ually results in a ne transfer price of 8.7@4 calculated asfollos:

Transfer price before reduction >@.@@$ess: %mega)s per=unit share of additional income

O2/@@4@@@ x 7@3 ; 1'4@@@ unitsP 1'.7@ e transfer price 8.7@

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Transfer Priin$! Sellin$ Internall, or E/ternall,

/. 9onoma Corporation is a multi=divisional company hose managers have been delegated full profit responsibility and complete autonomy to accept or re-ect transfers from other divisions.

!ivision I produces '4@@@ units of a subassembly that has a ready market. %ne of thesesubassemblies is currently used by !ivision G for each final product manufactured4 the latterof hich is sold to outsiders for 148@@. G)s sales during the current period amounted to '4@@@completed units. !ivision I charges !ivision G the 141@@ market price for the subassemblyHvariable costs are >7@ and 8@@ for !ivisions I and G4 respectively.

The manager of !ivision G feels that I should transfer the subassembly at a loer price because G is currently unable to make a profit.

&e#uired:A. Calculate the contribution margins 2total dollars and per unit3 of !ivisions I and G4 as

ell as the company as a hole4 if transfers are made at market price.

B. Assume that conditions have changed and I can sell only 14@@@ units in the market at?@@ per unit. Erom the company)s perspective4 should I transfer all '4@@@ units to G orsell 14@@@ in the market and transfer the remainder* ote: G)s sales ould decrease to14@@@ units if the latter alternative is pursued.

$%: 84 Type: A

Anser:A. !ivision I !ivision G Company

9ales at 148@@ /4'@@4@@@ /4'@@4@@@Transfers at 141@@ '4'@@4@@@ 2'4'@@4@@@3$ess: Lariable costs

at >7@ 214@@4@@@3at 8@@ 214'@@4@@@3 2'4?@@4@@@3

Contribution margin 7@@4@@@ 2'@@4@@@3 /@@4@@@

Jnit contribution margin '7@ 21@@3 17@

B. Alternative no. 1: Transfer '4@@@ units to !ivision G:

Company sales 2'4@@@ x 148@@3 /4'@@4@@@$ess: Lariable costs O'4@@@ x >7@3 < 2'4@@@ x 8@@3P '4?@@4@@@Contribution margin /@@4@@@

Alternative no. ': 9ell 14@@@ units in the open market and transfer 14@@@ units to G:

Company sales O214@@@ x ?@@3 < 214@@@ x 148@@3P '47@@4@@@$ess: Lariable costs O2'4@@@ x >7@3 < 214@@@ x 8@@3P '4/@@4@@@Contribution margin '@@4@@@

!ivision I should transfer all '4@@@ units to !ivision G to produce an additional1@@4@@@ 2/@@4@@@ = '@@4@@@3 of contribution margin.

1!2 Hilton, Managerial Accounting, Seventh Edition

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Transfer Priin$0 Ne$otiation

5. Dendall Corporation has to divisions: +hoenix and Tucson. +hoenix currently sells acondenser to manufacturers of cooling systems for 7'@ per unit. Lariable costs amount to

/>@4 and demand for this product currently exceeds the division)s ability to supply themarketplace.

Dendall is considering another use for the condenser4 namely4 integration into an enhancedrefrigeration system that ould be made by Tucson. &elated information about therefrigeration system follos.

9elling price of refrigeration system: 14'>7Additional variable manufacturing costs re#uired: >'@Transfer price of condenser: 5?@

Top management is anxious to introduce the refrigeration systemH hoever4 unless the transfer

is made4 an introduction ill not be possible because of the difficulty of obtaining condensersin the #uality and #uantity desired. The company uses responsibility accounting and &%0 inmeasuring divisional performance4 and aards bonuses to divisional management.

&e#uired:A. Mo ould +hoenix)s divisional manager likely react to the decision to transfer

condensers to Tucson* 9ho computations to support your anser.B. Mo ould Tucson)s divisional management likely react to the 5?@ transfer price* 9ho

computations to support your anser.C. Assume that a loer transfer price is desired. (hat parties should be involved in setting

the ne price*!. Erom a contribution margin perspective4 does Dendall benefit more if it sells the

condensers externally or transfers the condensers to Tucson* By ho much*

$%: 84 Type: A4

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Anser:A. The +hoenix divisional manager ill likely be opposed to the transfer. Currently4 the

division is selling all the units it produces at 7'@ each. (ith transfers taking place at 5?@4+hoenix ill suffer a /@ drop in sales revenue and profit on each unit that is sent to

Tucson.

B. Although Tucson is receiving a /@ 6price break6 on each unit purchased from +hoenix4 the5?@ transfer price ould probably be deemed too high. The reason: Tucson ill lose '7on each refrigeration system produced and sold.

9ales revenue 14'>7$ess: Lariable manufacturing costs >'@

Transfer price paid to +hoenix 5?@ 14/1@0ncome 2loss3 2'73

C. Dendall uses a responsibility accounting system4 aarding bonuses based on divisional performance. The to divisional managers 2or their representatives3 should negotiate amutually agreeable price.

!. Dendall ould benefit more if it sells the condenser externally. %bserve that the transfer price is ignored in this evaluationFone that looks at the firm as a hole.

+roduceCondenserH 9ell

"xternally

+roduce CondenserHTransferH 9ell

&efrigeration 9ystem9ales revenue 7'@ 14'>7

$ess: Lariable cost />@H />@ < >'@ />@ 14'@@

Contribution margin 15@ >7

1!! Hilton, Managerial Accounting, Seventh Edition

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%asi Transfer Priin$! -omesti and International Impliations

7. (alker4 0nc.4 has a +ennsylvania=based division that produces electronic components4 ith avery strong domestic market for circuit no. '''. The variable production cost is 15@4 and the

division can sell its entire output for 1?@. (alker is sub-ect to a /@ income tax rate.

Alternatively4 the +ennsylvania division can ship the circuit to a division that is located inississippi4 to be used in the manufacture of a global positioning system 2,+93. 0nformationabout the global positioning system and ississippi)s costs follo.

9elling price: />@ Circuit shipping and handling fees to ississippi: 1@

$abor4 overhead4 and additional material costs of ,+9: 1'@

&e#uired:A. Assume that the transfer price for the circuit as 18@. Mo ould +ennsylvania)s

divisional manager likely react to a corporate decision to transfer the circuits toississippi* (hy*

B. Calculate +ennsylvania income4 ississippi income4 and income for the company as ahole if the transfer took place at 18@ per circuit.

C. Assuming that transfers took place at a price higher than 18@4 ould the revised priceincrease4 decrease4 or have no effect on (alker)s income* Briefly explain.

!. Assume that (alker moved its ,+9 production facility to a division located in ,ermany4hich is sub-ect to a 57 tax rate. The transfer took place at 1>@. 9hipping fees2absorbed by the overseas division3 doubled to '@H the ,erman division paid an importduty e#ual to 1@ of the transfer priceH and labor4 overhead4 and additional material costsere 17@ per ,+9. 0f the ,erman selling price of the ,+9 amounted to 57@4 calculate+ennsylvania income4 ,erman income4 and income for (alker as a hole.

". 9uppose that J.9. and ,erman tax authorities alloed some discretion in ho transfer prices ere set. ,iven the difference in tax rates4 should (alker attempt to generate thema-ority of its income in +ennsylvania or ,ermany* (hy*

$%: 84 Type: &C4 A

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Anser:

A. The manager ould be unhappy4 as the division is being forced to take a 6hit6 of /@ percircuit 21?@ vs. 18@3.

B. +ennsylvania: 18@ = 15@ N '@H '@ = 2'@ x /@3 N 15ississippi: />@ = 1@ = 1'@ = 18@ N ?@H ?@ = 2?@ x /@3 N 8/(alker4 0nc.: 15 < 8/ N

C. (alker)s income is unaffected4 as the transfer price is a ash beteen the divisions. 0nother ords4 +ennsylvania)s revenue is offset by ississippi)s cost.

!. +ennsylvania: 1>@ = 15@ N 5@H 5@ = 25@ x /@3 N '>,ermany: 57@ = '@ = 17@ = 1>@ = 21>@ x 1@3 N >'H >' = 2>' x 573 N 57.1@(alker4 0nc.: '>.@@ < 57.1@ N /.1@

". Tax rates are loer in the J.9. than in ,ermany 2/@ vs. 573. Thus4 (alker ould

benefit if it generated the ma-ority of its income in +ennsylvania.

%asi Transfer Priin$! International

8. Cheney Corporation produces goods in the Jnited 9tates4 to be sold by a separate divisionlocated in 0taly. ore specifically4 the 0talian division imports units of product I/5 from theJ.9. and sells them for ?7@ each. 20mports of similar goods sell for >[email protected] The 0taliandivision is sub-ect to a 5@ tax rate hereas the J.9. tax rate is only /@. The manufacturingcost of product I/5 in the Jnited 9tates is '@. Eurthermore4 there is a 1@ import duty4computed on the transfer price4 that ill be paid by the 0talian division and is deductible hencomputing 0talian income.

Tax las of the to countries allo transfer prices to be set at J.9. manufacturing cost or theselling prices of comparable imports in 0taly.

&e#uired:Analyze the profitability of the J.9. division and the 0talian division to determine hetherCheney as a hole ould be better off if transfers took place at 213 J.9. manufacturing cost or 2'3 the selling price of comparable imports.

$%: 84 Type: A

Anser:Alternative no. 1: Transfer at J.9. manufacturing cost

Jnited 9tates: '@ = '@ N @0taly: ?7@ = '@ = 2'@ x 1@3 N 17>H 17> = 217> x 5@3 N ?5.>@Cheney Corporation: @ < ?5.>@ N ?5.>@

Alternative no. ': Transfer at selling price of comparable importsJnited 9tates: >7@ = '@ N 1/@H 1/@ = 21/@ x /@3 N ?10taly: ?7@ = >7@ = 2>7@ x 1@3 N 17H 17 = 217 x 5@3 N ?Cheney Corporation: ?1 < ? N 1@@


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Alternative no. ' ould be more profitable: 1@@.@@ vs. ?5.>@.

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International Transfer Priin$0 (nal,sis of Operations

. Cunningham4 0nc.4 hich produces electronic parts in the Jnited 9tates4 has a very stronglocal market for part no. 75. The variable production cost is 5@4 and the company can sell its

entire supply domestically for 11@. The J.9. tax rate is /@.

Alternatively4 Cunningham can ship the part to a division that is located in 9itzerland4 to beused in a product that the 9iss division ill distribute throughout "urope. 0nformation aboutthe 9iss product and the division)s operating environment follos.

9elling price of final product: 5@@9hipping fees to import part no. 75: '@$abor4 overhead4 and additional material costs of final product: '/@0mport duties levied on part no. 75 2to be paid by the 9iss division3: 1@ of transfer

price9iss tax rate: 5@

Based on J.9. and 9iss tax las4 the company has established a transfer price for part no. 75e#ual to the J.9. market price. Assume that the 9iss division can obtain part no. 75 in9itzerland for 1'7.

&e#uired:A. 0f you ere the head of the 9iss division4 ould you be better off to conduct business

ith your J.9. division or buy part no. 75 locally* (hy* 9ho computations.B. Cunningham)s accounting department has figured that the firm ill make 88.5@ for each

unit transferred and used in the 9iss division)s product. &ather than proceed ith thetransfer4 ould Cunningham be better off to sell its goods domestically and allo the9iss division to ac#uire part no. 75 in 9itzerland* 9ho computations for both J.9.

and 9iss operations to support your anser.C. ,enerally speaking4 hen tax rates differ beteen countries4 hat income strategy should

a company use in setting its transfer prices* 0f the seller is in a lo tax=rate country4 hattype of price should it set* (hy*

$%: 84 Type: A4

Anser:

A. Courtesy of the shipping fee and import duty4 both of hich can be avoided4 it is cheaperto purchase in 9itzerland at 1'7. The shipping fee and import duty raise the cost toac#uire parts from the J.9. operation to 151 211@ < '@ < 113.

B. Ges. Cunningham ill make 8 25? < '3 if no transfer takes place and part no. 75 issold in the J.9.

J.9. operation: 11@ = 5@ N @H @ = 2@ x /@3 N 5?9iss operation: 5@@ = 1'7 = '/@ N 57H 57 = 257 x 5@3 N '

C. (hen tax rates differ4 companies should strive to generate more income in lo tax=ratecountries4 and vice versa. Thus4 if the seller is in a lo tax=rate country4 it should set ahigh transfer price 2ithin alloed limits3 to increase that country)s income.


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-ISCUSSION QUESTIONS

-isadvanta$es of Return on Investment and Residual Inome

>. &eturn on investment 2&%03 and residual income 2&03 are popular measures of divisional

performance. $ike any measure4 there are disadvantages or eaknesses that are an inherent part of these tools. Briefly discuss a ma-or eakness associated ith each tool.

$%: 5 Type: &C

Anser:!ivisions ith high &%0s apparently are very successful. Top management ould thereforelike these managers to aggressively seek additional investment opportunities. Moever4 themanagers ill often re-ect opportunities that are attractive to the company as a hole but thathave a loer &%0 than a division)s current return.

&esidual income 2&03 does not have the same eakness as described above for &%0. Moever4

it is difficult to compare divisions of different sizes since &0 is not a percentage.

Return on Investment! (sset 'aluation

?. &eturn on investment 2&%03 is a very popular tool to evaluate performance. The measurementof &%0 is dependent4 in part4 on hether fixed assets are valued at ac#uisition cost or net bookvalue.

$ist several advantages of ac#uisition cost and net book value as ays to value long=livedassets.

$%: 7 Type: &C

Anser:Ac#uisition cost:• The investment base is not affected by the choice of an arbitrary depreciation

method.• The investment base does not shrink over time because of accumulated

depreciation. This avoids misleading increases in &%0 or residual income.

et book value:• Consistency ith the balance sheet is maintained.

• Consistency ith the definition of income is maintained4 as both the

numerator and denominator ill reflect depreciation amounts.

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.eneral Transfer+Priin$ Rule

>@. %ne element of the general transfer=pricing rule is opportunity cost. Briefly define the term6opportunity cost6 and then explain ho it is computed for 213 companies that have excess

capacity and 2'3 companies that have no excess capacity.

$%: 8 Type: &C

Anser:%pportunity cost is the benefit forgone by taking a particular action. Technically4 companiesthat have excess capacity are not forgoing profits from business that has been re-ectedH thus4the opportunity cost is zero. 0n contrast4 if a transfer is made in a firm that has no excesscapacity4 the firm ill have to give up profits on selected outside transactions. These profitsare measured by computing the contribution margin on lost sales in external marketplaces.

Ne$otiated Transfer Pries

>1. Although the general rule for transfer prices is the outlay cost plus opportunity cost4 manycompanies instead use negotiated prices to price their goods and services. (hen arenegotiated transfer prices used* Are such prices consistent or inconsistent ith responsibilityaccounting* "xplain.

$%: Type: &C4

Anser: egotiated transfer prices can be used hen no market price exists for the transferred productor hen a buying division can obtain a cheaper price outside of the organization.

egotiated prices are typically consistent ith responsibility accountingH they generally do notre#uire intervention by top management and thus help to preserve divisional autonomy. Thisis important since the divisional structure is predicated on the advantage of giving managers ahigh degree of responsibility for their unit operations.


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Ch 13 Hilton7

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