Exam 5 - Chapter 11 Equations

Question 1

Return on Investment: (ROI)

Answer 1

Net Operating Income / Average Operating Assets

and

Margin x Turnover

Question 2

Margin:

Answer 2

Net Operating Income / Sales

Question 3

Turnover:

Answer 3

Sales / Average Operating Assets

Question 4

Disadvantages of judging managers on ROI:

Answer 4

1. They might not fully understand how ROI can be manipulated and therefore increase it in an unhealthy way that may harm the company in the long run.
2. When managers take over an investment center, there are costs that they have and are used to calculate ROI, but that they cant immedietly get rid of. Making ROI not an accurate judgement of the performance of a newly highered manager.
3. Managers might reject investment opportunities that lower their investment center’s ROI even though those investments would be beneficial from the company’s perspective.

Question 5

Residual Income:

Answer 5

Net Operating Income - (Average Operating Assets x Minimum Required Rate of Return)

Question 6

Advantage of Judging a Manager on Residual Income:

Answer 6

1. Managers wont reject investment opportunities even if they decrease ROI.
2. Residual Income helps managers make investment decisions that benefit the company, not just their department.
3. Managers who are judged based on Residual Income will tend to make better investment decisions then those who use ROI.