MANAGEMENT ACCOUNTING CONCEPTS AND TECHNIQUES

By Dennis Caplan, University at Albany (State University of New York)

 

 

CHAPTER 22:Divisional Performance Measures

 

Exercises and Problems:

 

22-1: The Purini Dog Food Company has two divisions, the Puppy Chow Division and the Canine Elder Division. Operating results for the two divisions are as follows:

 

††††††††††††††††††††††††††††††††††††††††††††††††††††††††††† Puppy Chow Division†††††††††††††††††††††† Canine Elder Division

††††††††††† Net Operating Income††††††††††††††††††††††† ††††††††††† $10,000†††††††††††††††††††††††††††††††††† $6,000

††††††††††† Average Operating Assets††††††††††††††††† $50,000††††††††††††††††††††††††††††††††††† $42,000

 

The required rate of return, which is equal to the cost of capital, is 10%.

 

Required: A project with a return of $20,000 on an investment of $130,000 exists. If the divisions are evaluated based on return on investment, which division(s) would like to accept the project? If the divisions are evaluated based on residual income, which division(s) would like to accept the project?

 

 

22-2: Nummi Motors operates two divisions: the truck division and the car division. Nummiís hurdle rate (i.e., the cost of capital) is 10%. Following is information about the two divisions:

 

††††††††††††††††††††††††††††††††††††††††††††††††††††††††††† Truck Division††††††††††††††††††††††††††††††††††† Car Division

Divisional Income†††††††††††††††††††††††††††††† $1 million††††† ††††††††††††††††††††††† $2 million

Divisional Operating Assets†††††††††††††† $12 million††††† ††††††††††††††††††††††† $10 million

 

Required:

A) †††††† Calculate the truck divisionís residual income

 

B) †††††† Calculate the car divisionís return on investment

 

22-3: A company has two divisions: the Eastern division and the Western division. The cost of capital is 15%. Following is information about the two divisions:

 

 

Eastern Division

Western Division

Divisional profits

Divisional investment

$100,000

1,000,000

$200,000

1,000,000

 

Required:

A) †††††† Calculate each divisionís residual income, and residual income for the company as a whole

 

B) †††††† Calculate each divisionís return on investment, and return on investment for the company as a whole.

 

 

22-4: In 1980, the truck division of Motown Motors had return on sales of 15% and an asset turnover ratio of 50%. Sales were $100 million. Calculate the divisionís return on investment.

 

 

22-5: Recall that Residual Income is calculated by subtracting from NOPAT (Net operating profit after taxes) a charge for the cost of capital. If a company has interest expense and income tax expense, but no other income or expense line-items between operating income and net income, then NOPAT simply adds back to net income the after-tax effect of interest expense.

 

Arbatax has after-tax net income in 2007 of $34,000,000. The company has a marginal tax rate of 35%. The company incurred interest expense in 2007 of $6,000,000 (and the company earned no interest income). Arbatax had total assets in 2007 of $400,000,000. The companyís cost of capital is 8%.

 

Required: Determine the companyís Residual Income for 2007.

 

 

22-6: Following is selected information from the 2005 Annual Report of General Motors (some small miscellaneous line-items have been excluded, so that net income calculated from these numbers differs slightly from net income as per the annual report):

 

 

2005

2004

Automotive and Other Operations

Revenue

COGS, SG&A and other

 

Financing and Insurance Business

Revenue

Expenses

 

Interest expense

Net income tax benefit (increases income)

 

Total assets

Shareholders equity

 

$158,221,000,000

175,395,000,000

 

 

34,383,000,000

18,372,000,000

 

15,768,000,000

5,878,000,000

 

480,530,000,000

14,597,000,000

 

$161,545,000,000

162,087,000,000

 

 

31,972,000,000

18,264,000,000

 

11,980,000,000

916,000,000

 

482,347,000,000

27,360,000,000

 

Required: Calculate GMís pre-tax income, after-tax income, return on investment, and residual income for both 2005 and 2004. Combine both segments of the company for this exercise (automotive and financing). For return on investment, use pre-tax income in the numerator and total assets in the denominator. For residual income, use a 7% cost of capital, and a marginal tax rate of 30% to adjust for the tax effect of interest expense.

 


22-7: Following is selected information from the 2005 or 2006 financial statements of four airlines. All amounts are in 000ís.

 

 

Southwest Airlines

Alaska Airlines

Frontier Airlines

Midwest Express

Revenue

Operating income

Net interest expense

Pre-tax income

After-tax income

Total assets

Shareholders equity

$7,584,000

820,000

75,000

874,000

548,000

14,218,000

6,675,000

$2,416,100

-10,800

18,700

124,200

-2,300

3,511,900

626,900

$994,273

-7,897

12,392

-20,469

-13,971

970,432

228,776

$522,989

-65,168

-142

-65,026

-64,886

351,344

17,256

 

Required: Calculate ROI for each airline using net income and total assets. Break out each airlineís ROI into return on sales and the asset turnover ratio.

 

 

22-8: Following is selected financial information for four companies for 2005 (all amounts are in millions):

 

 

Apple Computer

 

Pepsi

 

Chevron

 

The GAP

Revenue

Total assets

Shareholder equity

Operating income

Net income

$13,931

11,551

7,466

1,650

1,335

$32,562

31,727

14,320

6,382

4,078

$198,200

125,833

62,676

25,197

14,099

$16,023

8,821

5,425

1,745

1,113

 

Required: Calculate each firmís return on investment (net income on total assets), return on sales, asset turnover ratio, and residual income using an 8% cost of capital. None of these firms incurred significant interest expense during the year.

 

 

22-9: Following is selected segment information for 2005 from the Annual Report for Starbucks.

 

 

United

States

(000ís)

International

 

(000ís)

Unallocated Corporate

(000ís)

Total

 

(000ís)

Revenue

Pre-tax earnings

Identifiable assets

$5,334,460

945,926

1,633,721

$1,034,840

86,421

605,750

$†††††††††††††† 0

- 235,903

1,274,594

$6,369,300

796,444

3,514,065

 

The total column agrees to the companyís 2005 income statement. In answering the following questions, because Starbucks has virtually no debt, interest expense can be ignored. Also, assume a 33% effective tax rate and a 7% cost of capital.


Required:

A) †††††† Calculate post-tax return on investment and post-tax residual income for the United States segment, the International segment, and for the company as a whole.

 

B) †††††† Explain why corporate-level residual income is less than the sum of the residual income of the two segments. Speculate as to the types of assets and expenses that are included as unallocated corporate. Identify the advantages and disadvantages of failing to allocate to the operating divisions significant corporate-level assets and expenses.

 

 

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Management Accounting Concepts and Techniques; copyright 2006; most recent update: November 2010

 

For a printer-friendly version, contact Dennis Caplan at dcaplan@uamail.albany.edu