50) Hudson Company has two divisions. The following information is available:
North Division South Division
Revenue for year$300,000$500,000
Operating income before taxes
for year$100,000$90,000
Average invested capital for year$100,000$200,000
Invested capital at end of year$200,000$300,000
Tax rate30%30%
After-tax cost of capital for year20%15%
Required:
1. Using operating income after taxes as the income measure, compute the following for each division:
A) Return on investment.
B) Return on sales
C) Capital turnover
D) Residual income
2. Which division is more successful? Why?
10.5 Questions
1) When a company uses economic profit as a performance metric, managers have an incentive to invest only in projects ________.
A) earning less than the return on investment of the segment or division
B) earning more than the return on investment of the segment or division
C) earning more than the cost of capital of the segment or division
D) earning less than the cost of capital of the segment or division
2) When a company uses return on investment as a performance metric, managers have an incentive to invest only in projects ________.
A) that increase the return on investment of the segment or division
B) that decrease the return on investment of the segment or division
C) that have a return on investment that exceeds the cost of capital of the segment or division
D) that have a return on investment that is less than the cost of capital of the segment or division
3) Brady Division has operating income of $200,000 for the year ending December 31, 2011. Average invested capital is $1,000,000 and the weighted-average cost of capital is 10%. The division is considering a new investment that would cost $500,000 and earn 15% annually. If return on investment is the performance metric, should the manager of the Brady Division accept the new investment?
A) No, because the return on investment of the division decreases with the new investment.
B) No, because the return on investment of the division increases with the new investment.
C) Yes, because the return on investment of the division decreases with the new investment.
D) Yes, because the return on investment of the division increases with the new investment.
4) Wisconsin Division has operating income of $40,000 for the year ending December 31, 2011. Average invested capital is $800,000 and the weighted-average cost of capital is 10%. The division is considering a new investment that would cost $800,000 and earn 7% annually. If return on investment is the performance metric, should the manager of the Wisconsin Division accept the new investment?
A) No, because the return on investment of the division decreases with the new investment.
B) No, because the return on investment of the division increases with the new investment.
C) Yes, because the return on investment of the division decreases with the new investment.
D) Yes, because the return on investment of the division increases with the new investment.
5) Bombard Division has operating income of $200,000 for the year ending December 31, 2011. Average invested capital is $1,000,000 and the weighted-average cost of capital is 10%. The division is considering a new investment that would cost $500,000 and earn 15% annually. If economic profit is the performance metric, should the manager of the Bombard Division accept the new investment?
A) No, because the return on investment of the division decreases with the new investment.
B) No, because the return on investment of the division increases with the new investment.
C) Yes, because the economic profit of the division increases with the new investment.
D) Yes, because the return on investment of the division increases with the new investment.
6) Wendell Division has operating income of $40,000 for the year ending December 31, 2011. Average invested capital is $800,000 and the weighted-average cost of capital is 10%. The division is considering a new investment that would cost $800,000 and earn 7% annually. If economic profit is the performance metric, should the manager of the Wendell Division accept the new investment?
A) No, because the return on investment of the division decreases with the new investment.
B) No, because the economic profit for the investment is negative.
C) Yes, because the economic profit for the investment is positive.
D) Yes, because the return on investment of the division increases with the new investment.
7) Use of ________ in evaluating capital investment projects will promote goal congruence and lead to better decisions than using ________.
A) return on investment; economic profit
B) economic profit; contribution by segment
C) contribution controllable by division manager; contribution by segment
D) economic profit, return on investment
8) Evaluation of capital investments based on economic profit motivates managers to invest in projects that ________ because those investments increase the division's economic profit.
A) earn a return in excess of the project's return on investment
B) earn a return in excess of the segment's return on investment
C) earn a return in excess of the cost of capital
D) earn a return in excess of the segment's net income
