napter 13 Ivestment Centers anat lraefer 611

Ostrate Two ways Ptcu

Dubai Division s
manager comid improve
improve the
the divisio' RO
t
ercise 13-24.
ent. Assume
hthat
e the company's
cowvpany's minimum festrel
deiret rate
rate of retst
Exercise13-26
on
Division's residual income for the Pesidl
0 2)
neoii
yea
Nueqoy ates, a real estate
y.he cost to developer and bilcing contractor Exercise 13-27
Dt, taking into Golden Gate of issuing deht is thehas altertwo m alraulato Weighted Average
e s equity account the fact that the mterest
tat
Cont of Captal for EVA
capital is the investment pavment are
Outd can on investments
of similaroppurtunity rat
otden (
ne interest rate on risk to that
ot
Golden Gate's S6) milion 1mveetng
rate is 40 percent. The cost of Grolden long term of

book value) of Golden Gate's Gate's cquity

capita
equity $0 ts
millin
on AssoCiates
weighted-average cost ot
capita
olden Gate Constructton Associates The has
Exercise 13-28
onstruction division. The dlivisions totai company Foonomic Value
the most recent assets. current Added t
year are as tollows Contrnuation of Precept
Exercise
(L0 2)
Total Assets Current Before-Tax
Liabilities Operating Income
*************************
STEMS $100,000,000 $6,000.000
****************°************** $20,000,000
60,000,000 4,000,000 18,000,000
Calculate the economic value added (EVA) for each
divisions. (You will need to use the of Golden Gate
Construction Associ
preceding exercise.) weighted-average cost of capital, which was
computed in the

wwalusing Industries has manufactured

prefabricated houses for over 20 years. The houses are
ctricted in sections to be assembled on customers' Exercise 13-29
con
ret when it acquired Fairmont
lots. Wyalusing expanded into the prccut housing ROI, Residual income
ket
Company, one of its mar- (LO 1,2)
nrecut into the appropriate lengths, banded into suppliers. In this market, various types of lumber are
packages, and
wwalusing designated the Fairmont Division as an investment shipped customers' lots for assembly.
to

nent (ROI) as a performance measure with investment center.

Wyalusing uses return invest- on
defined as
average productive assets. Management
honuses are based in part on ROI. All investments are
hefore income taxes. Fairmont's ROI has expected to earn a
minimum return of 15 percent
ranged from 19.3 to 22.l percent since it was
had an investment opportunity in 20x1 that had an
estimated ROI of 18 acquired. Fairmont
decided against the investment because it believed the percent. Fairmont's management
investment would decrease the division's overall
ROI. The 20x1 income statement for Fairmont Division
follows. The
S12.600,000 at the end of 20x1, a 5 percent increase over the balance atdivision's productive assets were
the beginning of the year.

FAIRMONT DIVISION
Income Statement
For the Year Ended December
31, 20x1
(in thousands)
Sales revenue . . . *****
****
$24,000
Cost of goods sold.. ***''***°**************'******
*************************'******************* *** 15,800
Gross margin. ** ********* *'*'''''*************'****'***
8,200
Operating expenses:
Administrative.****************"*****i*****"**** *ursnsereisnssasp. ,140
Selling..*************************************"**************************"*******'**** *uereore**nst.*
3,600 5,740
income from operations before income taxes ************************************************""*****"********************"******* $ 2,460
 612 Chapter 13 Investment Centers and Transfer Pricing

Required: Division.
measures for 20xI for the Fairmont
Calculate the following performance
a. Return on investment (ROI).
b. Residual income.
the investment
have been more likely to accept
2. Would the management of Fairmont Division measure instead of ROI?
were used as a performance
oPportunityit had in 20x1 if residual income
Explain your answer.
above. Show how
to solve requirement (1)
3. Builda spreadsheet: Construct an Excel spreadsheet
was $2,700,000.
the solution will change if income from operations

(CMA, adapted)

Exercise 13-30 Select one of the following companies (or any company of your choosing)
and use the Internet to explore
ROl and Residual Income;
thecompany's most recent annual report

The McGraw-Hill Companies

SPECIAL 1 2TH
SE INDIAN
EDITION EDITION

MANAGEMENT
CONTROL SYSTEMS
 scneauie as snoVIn In EXDiDl 15-5.
d

Problem 13-42 in tour separate dii-

of electronic products, organizedawarded
1s
ROl and Residual Income Megatronics Corporation, a massive retailer
and bonuses are based on ROI
four divisional managers are evaluated year-end,
at
Investment Evaluation SIons. The
on its investment.
a 13 percent return
(LO 2, 3, 4, 8) Last year, the company as a whole produced Eastern Division was approached
Middle
During the past week, management of the company's redirect its retail activities. (If the com
1Current RO: 21 decided to
about the possibility of buying a competitor that had
that follow relate to recent períor
5. Current residual ncome of book value.) The data
petitor is acquired, it will be acquired at its
the Middle Eastern Division mance of the Middle Eastern Division and the competitor:
$166,500 Middle Eastern Division Competitor
$8,400,000 $5,200,000
Sales ****''************ ********** * * * ********** *************** *

70% of sales 65% of sales

Variable costs... ****'*****
**************' ***** **'**********'**** '**** **************"****
*

Fixed costs. *********'*********

**********************************************
$2,131,500 $1,670,000
**** ***' *****

invested capital ************************************* ** *** ***** ****

**** $1,850,000 $625,000

the competitor to Megatronics' standards, an addi-

Management has determined that in order to upgrade
tional $375,000 of invested capital would be needed.
 615
Chapter 13 Investment Centers ard Transfer Pricing
Required: As a group, complete the following requirements.
1. Compute the current ROI of the Middle Eastern Division and the division's ROI if thecompetitor
bers to is acquired.
2. What is the likely reaction of divisional management toward the acquisition? Why?
nained 3. What is the likely reaction ofMegatronics' corporate management toward the acquisition? Why?
4. Would the division be better off if it acquired the competitor but didn't upgrade it to Megatronics
standards? Show computations to support your answer.
5. Assume that Megatronics uses residual income to evaluate performance and desires a 12 percent
minimum invested
return on capital.
Compute the current residual income of the Middle Eastern
Division and the division's residual income if the competitor is acquired. Will divisional manage
Sumptions ment be likely to change its attitude toward the acquisition? Why?
Problem 13-43
Li Ling-Fung, head of the Sporting Goods Division of Reliable Products, has just completed a miserable ROl and Performance
nine months. "1f it could have gone wrong, it did. Sales
are down. income down.
is inventories are too
Evaluations
worry that I will lose my job," he explained. Li is evaluated on
high, and quite frankly. I'm beginning to