Divisional Performance (2)

Question 1

Problems with ROI (Dysfucntional)

Answer 1

Dysfunctional behaviour only projects which increase ROI will be accepted, could be at the expense of growth in corproate profits

Question 2

Problems with ROI (Age of assets)

Answer 2

Ratio will be distorted by the age of the assets

Question 3

Problems with ROI (manipulated)

Answer 3

Profit can be manipulated

Question 4

If a manager’s bonus depends on ROI being met?

Answer 4

Manager may feel pressured into manipulating the measure

Question 5

How can asset base of ratio be altered to achieve a better ROI?

Answer 5

Can be altered by increasing/decreasing payables and receivables (by speeding up or delaying payments and receipts)

Question 6

What is residual income?

Answer 6

A measure of the centre’s profits after dedicting a national or imputed interest cost

Question 7

Advantages of RI (increase)

Answer 7

Residual income will increase where investments earning above the cost of capital are undertaken and investments earning below cost of capital are eliminated

Question 8

Advantages of RI (flexible)

Answer 8

Residual income is more flexible since a different cost of capital can be applied to investments with different risk characteristics

Question 9

Disadvantages of RI (comparisons)

Answer 9

Does not facilitate comparisons between investment centres, nor does it relate the size of a centre’s income to size of investment

Question 10

If a company has two identical divisions but one is four years older than the other?

Answer 10

Older division will have suffered more depreciation and will therefore have a lower capital employed

Question 11

How will RI favour the older division?

Answer 11

As the imputed interst (capital employed multiplied by cost of capital) for the older division will be smaller