Question : ESSAY. Write your answer in the space provided or a separate : 1196212

 

ESSAY.

Write your answer in the space provided or on a separate sheet of paper. 86)

The executive vice president of Wicker Pen Company wants to establish an accounting-based performance measurement system for the company’s new plant. The company has an accounting information system sufficient to support a fairly sophisticated performance measurement system. The new plant is going to be considered an investment centre since its products will be marketed differently from others the company currently sells and it has no internal dealings with other plants within the company.

Required:

What are some of the key steps that should be undertaken in the establishment of such a performance measurement system?

87)

Endicott Inc. has four divisions.

Each division produces and sells a variety of industrial products.

The company is developing a compensation plan for division managers.

Three options are being considered:

(a) salary, (b) performance based incentive using RI, (c) mix of salary and a performance based incentive using RI.

What factors should be considered in designing this plan?

 

88)

Bob Cellular Phone uses ROI to measure divisional performance. Annual ROI calculations for each division have traditionally employed the ending amount of invested capital along with annual operating income and net revenue. The duPont method is generally used. The company’s Phone Accessories Division had the following results for the last two years:

 

2001 ROI = ($2,000,000/$20,000,000) x ($20,000,000/$10,000,000) = 0.20

2002 ROI = ($2,400,000/$25,000,000) x ($25,000,000/$15,000,000) = 0.16

 

Corporate management was disappointed in the performance of the division for 2002 since it had made an additional investment in the division which was budgeted for a 23 percent ROI.

 

Required:

 

a.Discuss some factors that may have contributed to the decrease in ROI for 2002.

b.Assume ‘total assets employed’ are 10% less than total assets. What is the effect of using ‘total assets employed’ when calculating ROI?

89)

R & D Storage is a small, but diversified, moving and storage company. In recent years its corporate income has declined to unacceptable levels. To change the direction of the company, the board of directors hired a new chief executive officer. She is currently considering three alternative ways as to how division managers are rewarded for their performance. They are; ROI, RI, and EVA.

 

Required:

 

Evaluate the CEO’s plans.

90)

The economic value added concept has attracted considerable attention in recent years. Explain the

attractiveness of this number as a measure of performance.

 

91)

Briefly explain each of the four levers of control.

Why does a company need to implement more than a

diagnostic control system?

 

1)

TRUE 2)

FALSE 3)

TRUE 4)

TRUE 5)

FALSE 6)

FALSE 7)

TRUE 8)

TRUE 9)

FALSE 10)

FALSE 11)

TRUE 12)

TRUE 13)

TRUE 14)

TRUE 15)

FALSE 16)

TRUE 17)

FALSE 18)

TRUE 19)

FALSE 20)

FALSE 21)

A 22)

E 23)

B 24)

D 25)

D 26)

D 27)

C 28)

A 29)

D 30)

D 31)

C 32)

A 33)

E 34)

D 35)

D 36)

C 37)

D 38)

E 39)

D 40)

C 41)

A 42)

A 43)

A 44)

A 45)

C 46)

B 47)

B 48)

D 49)

B 50)

D 51)

D 52)

B 53)

C 54)

A 55)

A 56)

C 57)

B 58)

A 59)

A 60)

B 61)

C 62)

E 63)

B 64)

D 65)

C 66)

C 67)

B 68)

C 69)

D 70)

B 71)

1.Choose performance measures that align with top management’s goals.

Does operating income, return on assets, or revenues best measure a subunit’s financial goals?

2.Choose the time horizon of each performance measure.

Should the performance measures be calculated for one year or a multiyear time horizon?

3.Choose a definition for each performance measure.

Should assets be defined as total assets or net assets?

4.Choose a measurement alternative for each performance measure.

Should assets be measured at historical cost or current cost?

5.Choose a target level of performance.

Should all subunits have the same targets such as the same required rate of return on assets?

6.Choose the timing of the feedback.

How often should manufacturing performance reports be sent to management?

 

72)

a.Riddler ROI= $1,000,000/$9,000,000= 0.111

Joker ROI= $1,750,000/$10,000,000= 0.175

Penguin ROI= $2,520,000/$14,000,000= 0.180

 

b.

 

Riddler

Joker

Penguin

Investment base

$9,000,000

$10,000,000

$14,000,000

Minimum rate

x

 

 

0.20

x

 

 

0.20

x

 

 

0.20

 

 

Minimum return

$1,800,000

$2,000,000

$2,800,000

 

 

 

 

Income

$1,000,000

$1,750,000

$2,520,000

Minimum return

1,800,000

2,000,000

2,800,000

 

 

Residual income

$(800,000)

$ (250,000)

$(280,000)

 

c.ROI Rank:

Penguin # 1

Joker # 2

Riddler # 3

 

RI Rank:

Joker #1

Penguin #2

Riddler #3

73)

East ROI= $4,500,000/$30,000,000 = 0.150

West ROI= $4,750,000/$30,500,000 = 0.156

International = $5,000,000/$31,000,000 = 0.161

 

b.

 

East

 

 

 

West

 

 International

Investment base$30,000,000$30,500,000$31,000,000

Minimum ratex

 

 

 

 

0.15x

 

 

 

 

0.15 x

 

 

 

 

0.15

 

Minimum return$

4,500,000$ 4,575,000$ 4,650,000

 

Income$ 4,500,000$ 4,750,000$ 5,000,000

Minimum return4,500,0004,575,000 4,650,000

 

Residual income

 

 

 

 

 

 

 

$ 0 $

175,000 $

350,000 74)

a.Investment turnover:

Plows= $2,250,000/$1,000,000= 2.25

Tractors= $500,000/$400,000= 1.25

Combines= $4,800,000/$1,750,000= 2.74

 

b.Return on Sales:

Plows= $220,000/$2,250,000= 0.10

Tractors= $60,000/$500,000= 0.12

Combines= $480,000/$4,800,000= 0.10

 

c.ROI:

Plows= 2.25 x 0.10= 0.225

Tractors= 1.25 x 0.12= 0.150

Combines= 2.74 x 0.10= 0.274

 

d.Combines’ manager had the best performance because he had the highest investment turnover, which offset his second-best return on sales.

 

e.Residual income should be considered and noncontrollable factors such as the age of the assets.

75)

a.R-division ROI = $1,000,000/$9,000,000 = 0.111

J-division ROI = $1,750,000/$10,000,000 = 0.175

G-division ROI = $2,520,000/$14,000,000 = 0.180

 

b.R-divisionJ-divisionG-division

Investment base$9,000,000$10,000,000$14,000,000

Minimum ratex

 

 

 

0.20x

 

 

 

 

0.20x

 

 

 

 

0.20

 

Minimum return$1,800,000$ 2,000,000$ 2,800,000

 

Income$1,000,000$ 1,750,000$ 2,520,000

Minimum return1,800,0002,000,0002,800,000

 

Residual income$( 800,000)$( 250,000)$ ( 280,000)

 

 

c.ROI Rank: G-division # 1RI Rank: J-division #1

J-division # 2G-division #2

R-division # 3R-division #3

 

d.As to which division was the best, it is difficult to determine without knowing what the results are being used to evaluate. If management is measuring only the return of capital the G-division Division has the highest ranking, although not much ahead of J-division. However, G-division does have a substantially higher income level. As to meeting management’s expectations of residual income, all divisions fall short of the goal with J-division being slightly ahead of G-division. 76)

a.Montreal

= $25,500/$150,000 = 0.170

Toronto

 = $28,000/$125,000 = 0.224

Vancouver = $29,500/$175,000 = 0.169

 

b.Toronto was doing the best because the ROI was the highest, and as compared to Vancouver was doing better with fewer assets.

 

c.The company could consider examining the duPont method, residual income, and EVA, and ROS, and also consider the time horizon of whatever performance it chooses. 77)

a.Target Operating income = 0.20 x $1,500,000 = $300,000

Operating income $300,000

Variable costs 400,000

Fixed costs 250,000

Target revenues950,000

 

Sales volume = $950,000/$100 = 9,500 units

 

b.Asset base

$1,500,000

Minimum rate

x

 

 

 

 

0.18

Required return $270,000

Target operating income$300,000

Required return 270,000

Residual income $ 30,000

 

Bonus = $30,000 x 0.50 =               $15,000 78)

a.

New investment:

Sales$1,600,000

Variable costs $960,000

Fixed costs600,000 1,560,000

Operating income$

 

 

40,000

 

Current ROI = $700,000/$3,600,000 = 0.194

 

New investment ROI = $40,000/$600,000 = 0.067

 

Combined ROI = $740,000/$4,200,000 = 0.176

 

Accepting the new product line will reduce the division’s ROI. This

would make the manager reluctant to make the investment.

 

b.

Investment $600,000

Minimum returnx

 

0.06

Required amount $ 36,000

 

Income $40,000

Required amount 36,000

Residual income$ 4,000

 

Manager would accept investment because income is increased by $4,000. 79)

a.A ROI = $15,000,000/$100,000,000 = 0.15

B ROI = $25,000,000/$125,000,000 = 0.20

C ROI = $11,000,000/$50,000,000

= 0.22

 

b.A RI = $15,000,000 – ($100,000,000 x 0.15) = $

0

B RI = $25,000,000 – ($125,000,000 x 0.15) = $6,250,000

C RI = $11,000,000 – ($50,000,000 x 0.15)

= $3,500,000

 

c.ROI Rank:RI Rank:

1. C1. B

2. B2. C

3. A3. A

 

d.A ROI = $19,500,000/$125,000,000 = 0.156

B ROI = $29,500,000/$150,000,000 = 0.197

C ROI = $15,500,000/$75,000,000

= 0.207

 

A RI = $19,500,000 – ($125,000,000 x 0.15) = $ 750,000

B RI = $29,500,000 – ($150,000,000 x 0.15) = $7,000,000

C RI = $15,500,000 – ($75,000,000 x 0.15)

= $4,250,000

 

e.Everyone is pleased that only residual income is used because their residual incomes go up. However, it is difficult to evaluate on a comparative basis because the investment base is very different for the divisions.

 

Only the manager of A is pleased with the new investment if ROI is used because that is the only division where ROI increased. In the case of additional investments which are required by corporate management, residual income may be the best to use for evaluating each manager individually but not collectively. 80)

a.ROI: Plows:= 2.25 x 0.10 = 0.225

Tractors: = 1.25 x 0.12 = 0.150

Combines: = 2.74 x 0.10 = 0.274

 

b.PlowsTractorsCombines

Net operating income220,00060,000480,000

( 1 – tax rate).65.65.65

after-tax income$143,000$260,000$312,000

 

(Total assets – current liabilities)$750,000$300,000$1,000,000

WACC11.5%11.5%11.5%

sub-totals$86,250$34,500$115,000

 

after-tax income$143,000$260,000$312,000

Less: sub-totals$ 86,250$34,500$115,000

Economic value-added$56,750$225,500$197,000

 

c.Residual income should also be considered. 81)

a.A ROI= $15,000,000/$100,000,000= 0.15

B ROI= $25,000,000/$125,000,000= 0.20

C ROI= $11,000,000/$50,000,000 = 0.22

 

b.A RI= $15,000,000 — ($100,000,000 x 0.15)= $ 0

B RI= $25,000,000 — ($125,000,000 x 0.15)= $6,250,000

C RI= $11,000,000 — ($50,000,000 x 0.15) = $3,500,000

 

c.ROI Rank: 1. CRI Rank: 1. B

2. B2. C

3. A3. A

 

82)

a.

Canadian Division’s ROI for 2008 =

 

$2,400,000 / $16,000,000 = 15%

 

b.

Chinese Division’s ROI for 2008 = 11,400,000 yuan / 75,000,000 yuan

 = 15.2%

 

c.

Three steps are used to determine the answer.

First, convert total assets in the Chinese Divison into dollars at the December 31, 2007, exchange rate, the rate prevailing when these assets were acquired (7.5 yuan = $1):

 

Total assets =

 

75,000,000 yuan / 7.5 yuan per dollar

 =

$10,000,000

 

Second, convert operating income in the Chinese Division into dollars at the average exchange rate prevailing during 2008 when the operating income was earned:

 

11,400,000 yuan / 8 yuan per dollar

= $1,425,000

 

Third, calculate the Chinese Division’s comparable ROI for 2008 = $1425,000 / $10,000,000 = 14.25%

 

The Chinese Division’s ROI measured in yuan is helped by the inflation that occurred in China during 2008 because inflation boosted the Chinese Division’s operating income.

Given that the assets were acquired on December 31, 2007, the asset values should not be increased to reflect the inflation that occurred during 2008.

The net effect of inflation on ROI calculated in yuan is to use an inflated value in the numerator relative to the denominator.

Adjusting for inflation using currency differences that represent differential inflation negates the effects of any differences in inflation rates between the two countries on the calculation of ROI.

After these adjustments, the Canadian Division shows a higher ROI (15% from part (a) above) than the Chinese Division (14.25%). 83)

Red Division:

ROI = NI ÷ TA

200,000 ÷ 1,250,000

= 0.16

 

ROS = Income/Sales

0.04 = $200,000/Sales

Sales = $5,000,000

 

White Division:

ROS = $400,000/$10,000,000

= 0.04

 

TA = NI ÷ ROI

= $400,000 ÷ 0.10

= $4,000,000

 

Blue Division:

Sales = NI ÷ ROS

= 288,000 ÷ 0.12

= $2,400,000

 

ROI = (2,400,000 ÷1,600,000) x (288,000 ÷ 2,400,000) = 0.18 84)

a.Book value ROI: Eastern = $120,000/$600,000

 

= 0.200

Midwestern = $120,000/$700,000 = 0.171

Western = $200,000/$1,000,000

= 0.200

 

Current ROI: Eastern = $110,000/$900,000

 

= 0.122

Midwestern = $120,000/$700,000 = 0.171

Western = $180,000/$1,400,000

= 0.129

 

b.Book value RI: Eastern = $120,000 – ($600,000 x 0.15)

 

= $30,000

Midwestern = $120,000 – ($700,000 x 0.15) = $15,000

Western = $200,000 – ($1,000,000 x 0.15)

= $50,000

 

Current RI: Eastern = $110,000 – ($900,000 x 0.15)

 = ($25,000)

Midwestern = $120,000 – ($700,000 x 0.15) = $15,000

Western = $180,000 – ($1,400,000 x 0.15)

=($30,000)

 

c.Because it reflects current costs, current value is generally better than book value. Using this basis, the Midwestern Division is the most successful. It has the highest ROI and RI. 85)

a.income ÷ 13,000,000 CU’s = .20

income = 2,600,000 CU’s

 

b.Total Assets x old exchange rate = 13,000,000 CU’s to 1 Cdn dollar

Old exchange rate = 4 CU’s to 1 Cdn dollar

Average exchange rate = (4 + 8) ÷ 2 = 6 CU’s to 1 Cdn dollar

2,600,000 CU’s ÷ 6 = $433,333

$433,333 ÷ $3,250,000 = 13.33%

 

c.$433,333 – (0.13 x 3,250,000) = $10,833

86)

Key steps include:

 

1.Choosing variables that represent the company’s financial goals for the plant.

2.Choose the time horizon of each performance measure.

3.Choose definitions of the variables selected in step #1.

4.Choose measures for the items included in the variables in step #1.

5.Choose a target against which to gauge performance.

6.Choose the timing of feedback. 87)

The basic trade-off to consider in designing the compensation plan for division managers is between creating incentives to get managers to work hard and imposing risk on them.

Compensation based on RI creates incentives for the managers to work hard, but they also bear risk because RI is affected by some factors outside their control.

For example, a division manager may work hard but uncontrollable factors (such as economic conditions) may cause RI to be reduced, thereby reducing the manager’s compensation.

A salary, independent of RI performance, does not impose any risk on managers but it also creates no incentives for them.

For this reason, many companies use a mix of salary and a performance based incentive – the salary component reduces risk while the performance based component creates incentives. 88)

a.While sales increased by 25 percent, net income only increased by 20 percent. This may indicate that expenses increased more than they should have. Apparently the expected marginal net income from the new investment was $1,150,000 ($5,000,000 x 0.23), and either sales were too low or expenses high for the new products. Start-up costs may have also contributed to the increased expenses of the first year’s operations.

 

b.Total assets employed, = $10,000,000 x 90% = $9,000,000

ROI = $2,400,000/$9,000,000 = 0.267

 

Using this formulation of ROI, management would be pleased with their results, since actual results exceed the budget results. 89)

If only one measure is to be used, the CEO has to decide what is most important to measure. A good start would be working through the 5-step procedure noted in this chapter.

 

ROI and RI consider income and the investment made, although ROI may introduce goal congruence problems. The CEO should consider the possibility of a multi-year time horizon, as the benefits of a manager’s actions may not be evident in income until some time in the future (ie, the long-term), and it would be unwise to encourage managers to focus solely on the short-term. Economic value-added would be relevant if the CEO wants to be able to include tax effects in the performance measure. 90)

The attractiveness of economic value added at the divisional level is primarily the fact that it allows managers to incorporate the cost of capital in decisions at the divisional level.

The economic value added concept, like residual income, charges managers for the cost of their investments in long-term assets and working capital.

Value is created only if after-tax operating income exceeds the cost of investing the capital.

To improve economic value added, managers must earn more operating income with the same capital, use less capital, or invest capital in high-return projects.

91)

The four levers of control are diagnostic control systems, boundary systems, belief systems, and interactive control systems. Companies must strive for performance, behave ethically, inspire employees, and respond to strategic threats and opportunities in the environment.

Diagnostic control systems involve measures that help a company to diagnose whether or not a company is performing according to expectations.

Boundary systems describe standards of behavior and codes of conduct expected of all employees, especially actions that are off-limits. Belief systems articulate the mission, purpose, and core values of a company. Interactive control systems are formal information systems that managers use to focus organization attention and learning on key strategic issues.

 

The “levers of control,” in addition to diagnostic control systems, are needed since the pressure to perform on diagnostic goals can be so strong that management might take steps to cut corners and make their performance look better than it really is.

In addition, diagnostic systems might focus management too much on meeting short term goals that organization learning and attention to key strategic issues might be inadequate for the future.