ACCA PM Syllabus E. Performance Measurement And Control - ROI and RI - Past Papers ^{2 / 2}

Sports Co is a large manufacturing company specialising in the manufacture of a wide range of sports clothing and equipment. The company has two divisions: Clothing (Division C) and Equipment (Division E). Each division operates with little intervention from Head Office and divisional managers have autonomy to make decisions about long-term investments.

Sports Co measures the performance of its divisions using return on investment (ROI), calculated using controllable profit and average divisional net assets. The target ROI for each of the divisions is 18%. If the divisions meet or exceed this target the divisional managers receive a bonus.

Last year, an investment which was expected to meet the target ROI was rejected by one of the divisional managers because it would have reduced the division’s overall ROI. Consequently, Sports Co is considering the introduction of a new performance measure, residual income (RI), in order to discourage this dysfunctional behaviour in the future. Like ROI, this would be calculated using controllable profit and average divisional net assets.

The draft operating statement for the year, prepared by the company’s trainee accountant, is shown below:

Notes:
(1) Included in the fixed costs are depreciation costs of $165,000 and $460,000 for Divisions C and E respectively.

30% of the depreciation costs in each division relates to assets controlled but not owned by Head Office.

Division E invested $2m in plant and machinery at the beginning of the year, which is included in the net assets figures above, and uses the reducing balance method to depreciate assets. Division C, which uses the straight-line  method, made no significant additions to non-current assets. It is the policy of both divisions to charge a full year’s depreciation in the year of acquisition.

(2) Head Office recharges all of its costs to the two divisions. These have been included in the fixed costs and amount to $620,000 for Division C and $700,000 for Division E.

(3) Sports Co has a cost of capital of 12%.

Required:
(a) (i) Calculate the return on investment (ROI) for each of the two divisions of Sports Co. (6 marks)

(ii) Explain the advantages and disadvantages of using residual income (RI) to measure divisional performance. (4 marks)

A company has two divisions. The divisions are identical in terms of the number and type of machines they have and the operations they carry out. However, one division was set up four years ago and the other was set up one year ago. Head office appraises the division using both return on the investment (ROI) and residual income (RI).

Which of the following statements is correct in relation to the outcome of the appraisal for each division?

A. Both ROI and RI will favour the older division
B. ROI will favour the older division, but RI will treat each fairly
C. RI will favour the newer division and ROI will favour the older division
D. Both RI and ROI will favour the newer division

A government is trying to assess schools by using a range of financial and non-financial factors. One of the chosen methods is the percentage of students passing five exams or more.

Which of the three Es in the value for money framework is being measured here?

A    Economy
B    Efficiency
C    Effectiveness 
D    Expertise

At the end of 20X1, an investment centre has net assets of $1m and annual operating profits of $190,000. However, the bookkeeper forgot to account for the following:

A machine with a net book value of $40,000 was sold at the start of the year for $50,000 and replaced with a machine costing $250,000.

Both the purchase and sale are cash transactions. No depreciation is charged in the year of purchase or disposal. The investment centre calculates return on investment (ROI) based on closing net assets.

Assuming no other changes to profit or net assets, what is the return on investment (ROI) for the year?

A 18·8% 
B 19·8% 
C 15·1% 
D 15·9%

Cardale Industrial Metal Co (CIM Co) is a large supplier of industrial metals. The company is split into two divisions: Division F and Division N. Each division operates separately as an investment centre, with each one having full control over its non-current assets. In addition, both divisions are responsible for their own current assets, controlling their own levels of inventory and cash and having full responsibility for the credit terms granted to customers and the collection of receivables balances. Similarly, each division has full responsibility for its current liabilities and deals directly with its own suppliers.

Each divisional manager is paid a salary of $120,000 per annum plus an annual performance-related bonus, based on the return on investment (ROI) achieved by their division for the year. Each divisional manager is expected to achieve a minimum ROI for their division of 10% per annum. If a manager only meets the 10% target, they are not awarded a bonus. However, for each whole percentage point above 10% which the division achieves for the year, a bonus equivalent to 2% of annual salary is paid, subject to a maximum bonus equivalent to 30% of annual salary.

The following figures relate to the year ended 31 August 2015:

During the year ending 31 August 2015, Division N invested $6·8m in new equipment including a technologically advanced cutting machine, which is expected to increase productivity by 8% per annum. Division F has made no investment during the year, although its computer system is badly in need of updating. Division F’s manager has said that he has already had to delay payments to suppliers (i.e. accounts payables) because of limited cash and the computer system ‘will just have to wait’, although the cash balance at Division F is still better than that of Division N.

Required:
(a) For each division, for the year ended 31 August 2015, calculate the appropriate closing return on investment (ROI) on which the payment of management bonuses will be based. Briefly justify the figures used in your calculations.

Note: There are 3 marks available for calculations and 2 marks available for discussion. (5 marks)

Cardale Industrial Metal Co (CIM Co) is a large supplier of industrial metals. The company is split into two divisions: Division F and Division N. Each division operates separately as an investment centre, with each one having full control over its non-current assets. In addition, both divisions are responsible for their own current assets, controlling their own levels of inventory and cash and having full responsibility for the credit terms granted to customers and the collection of receivables balances. Similarly, each division has full responsibility for its current liabilities and deals directly with its own suppliers.

Each divisional manager is paid a salary of $120,000 per annum plus an annual performance-related bonus, based on the return on investment (ROI) achieved by their division for the year. Each divisional manager is expected to achieve a minimum ROI for their division of 10% per annum. If a manager only meets the 10% target, they are not awarded a bonus. However, for each whole percentage point above 10% which the division achieves for the year, a bonus equivalent to 2% of annual salary is paid, subject to a maximum bonus equivalent to 30% of annual salary.

The following figures relate to the year ended 31 August 2015:

During the year ending 31 August 2015, Division N invested $6·8m in new equipment including a technologically advanced cutting machine, which is expected to increase productivity by 8% per annum. Division F has made no investment during the year, although its computer system is badly in need of updating. Division F’s manager has said that he has already had to delay payments to suppliers (i.e. accounts payables) because of limited cash and the computer system ‘will just have to wait’, although the cash balance at Division F is still better than that of Division N.

Required:
(b) Based on your calculations in part (a), calculate each manager’s bonus for the year ended 31 August 2015. (3 marks)

Cardale Industrial Metal Co (CIM Co) is a large supplier of industrial metals. The company is split into two divisions: Division F and Division N. Each division operates separately as an investment centre, with each one having full control over its non-current assets. In addition, both divisions are responsible for their own current assets, controlling their own levels of inventory and cash and having full responsibility for the credit terms granted to customers and the collection of receivables balances. Similarly, each division has full responsibility for its current liabilities and deals directly with its own suppliers.

Each divisional manager is paid a salary of $120,000 per annum plus an annual performance-related bonus, based on the return on investment (ROI) achieved by their division for the year. Each divisional manager is expected to achieve a minimum ROI for their division of 10% per annum. If a manager only meets the 10% target, they are not awarded a bonus. However, for each whole percentage point above 10% which the division achieves for the year, a bonus equivalent to 2% of annual salary is paid, subject to a maximum bonus equivalent to 30% of annual salary.

The following figures relate to the year ended 31 August 2015:

During the year ending 31 August 2015, Division N invested $6·8m in new equipment including a technologically advanced cutting machine, which is expected to increase productivity by 8% per annum. Division F has made no investment during the year, although its computer system is badly in need of updating. Division F’s manager has said that he has already had to delay payments to suppliers (i.e. accounts payables) because of limited cash and the computer system ‘will just have to wait’, although the cash balance at Division F is still better than that of Division N.

Required:
(c) Discuss whether ROI is providing a fair basis for calculating the managers’ bonuses and the problems arising from its use at CIM Co for the year ended 31 August 2015. (7 marks)

A division is considering investing in capital equipment costing $2·7m. The useful economic life of the equipment is expected to be 50 years, with no resale value at the end of the period. The forecast return on the initial investment is 15% per annum before depreciation. The division’s cost of capital is 7%.

What is the expected annual residual income of the initial investment?

A. $0
B. ($270,000)
C. $162,000
D. $216,000

What is the return on capital employed for the company?
A. 27·3%
B. 18·2%
C. 11·2%
D. 16·8%

At the start of the year, a division has non-current assets of $4 million and makes no additions or disposals during the year. Depreciation is charged at a rate of 10% per annum on all non-current assets held at the end of the year. Working capital is $0·5 million at the start of the year although this is expected to increase by 20% by the end of the year. The budgeted profit of the division after depreciation is $1·2m.

What is the expected ROI of the division for the year, based on average capital employed?
A. 27·59%
B. 26·37%
C. 18·39%
D. 31·58%

Dust Co has two divisions, A and B. Each division is currently considering the following separate projects:
                                                                   Division A                                      Division B
Capital required for the project                $32·6 million                                  $22·2 million
Sales generated by project                      $14·4 million                                    $8·8 million
Operating profit margin                                          30%                                               24%
Cost of capital                                                        10%                                               10%
Current return on investment of division                15%                                                 9%

If residual income is used as the basis for the investment decision, which Division(s) would choose to invest in
the project?
A     Division A only
B     Division B only
C     Both Division A and Division B
D     Neither Division A nor Division B

Brace Co is split into two divisions, A and B, each with their own cost and revenue streams. Each of them is managed by a divisional manager who has the power to make all investment decisions within the division. The cost of capital for both divisions is 12%. Historically, investment decisions have been made by calculating the return on investment (ROI) of any opportunities and at present, the return on investment of each division is 16%.

A new manager who has recently been appointed in division A has argued that using residual income to make investment decisions would result in ‘better goal congruence’ throughout the company.

Each division is currently considering the following separate investments:

Required:
(a) Calculate the return on investment for each of the two divisions. (2 marks)

Brace Co is split into two divisions, A and B, each with their own cost and revenue streams. Each of them is managed by a divisional manager who has the power to make all investment decisions within the division. The cost of capital for both divisions is 12%. Historically, investment decisions have been made by calculating the return on investment (ROI) of any opportunities and at present, the return on investment of each division is 16%.

A new manager who has recently been appointed in division A has argued that using residual income to make investment decisions would result in ‘better goal congruence’ throughout the company.

Each division is currently considering the following separate investments:

Required:
(b) Calculate the residual income for each of the two divisions. (4 marks)

Brace Co is split into two divisions, A and B, each with their own cost and revenue streams. Each of them is managed by a divisional manager who has the power to make all investment decisions within the division. The cost of capital for both divisions is 12%. Historically, investment decisions have been made by calculating the return on investment (ROI) of any opportunities and at present, the return on investment of each division is 16%.

A new manager who has recently been appointed in division A has argued that using residual income to make investment decisions would result in ‘better goal congruence’ throughout the company.

Each division is currently considering the following separate investments:

Required:
(c) Comment on the results, taking into consideration the manager’s views about residual income. (4 marks)