*SECTION A: 20 MCQs with Answers*
*1. ROI is calculated as:*
A. Net Income / Sales
B. Net Income / Invested Capital
C. Contribution / Sales
D. Sales / Invested Capital
*Ans: B* - `ROI = Net Operating Income / Average Invested Capital`. Also = Margin × Turnover
*2. The main disadvantage of ROI is:*
A. Hard to calculate
B. May cause sub-optimization / managers reject projects > cost of capital but < current ROI
C. Ignores sales
D. Cannot compare divisions
*Ans: B* - Managers may reject profitable projects if it lowers their ROI
*3. Residual Income (RI) is:*
A. Net Income - Interest Expense
B. Operating Income - (Invested Capital × Required Rate of Return)
C. Sales - Variable Costs
D. ROI × Invested Capital
*Ans: B* - `RI = NOI - (Avg Invested Capital × RRR)`. Better than ROI for goal congruence
*4. Which is better for comparing divisions of different sizes?*
A. ROI
B. RI
C. Sales
D. Net Income
*Ans: A* - ROI is a % so size doesn’t matter. RI is in $ so hard to compare
*5. A responsibility center where manager controls costs only is called:*
A. Profit Center
B. Investment Center
C. Cost Center
D. Revenue Center
*Ans: C* - Ex: Production dept, Maintenance dept
*6. A division where manager controls revenue and costs is:*
A. Cost Center
B. Profit Center
C. Investment Center
D. Revenue Center
*Ans: B* - Ex: Sales division
*7. A division where manager controls revenue, costs AND invested assets is:*
A. Cost Center
B. Profit Center
C. Investment Center
D. Expense Center
*Ans: C* - ROI and RI are used to evaluate
*8. Transfer Price set at Market Price is best when:*
A. No external market exists
B. Market is perfectly competitive
C. Selling division has excess capacity
D. Buying division is inefficient
*Ans: B* - Market price = Goal congruence + Autonomy
*9. Transfer Price set at Variable Cost + Markup is used when:*
A. Market price is available
B. No external market and selling division has spare capacity
C. Company wants to avoid tax
D. Both divisions are profit centers
*Ans: B* - Cost-based method
*10. If selling division has no excess capacity, the minimum transfer price should be:*
A. Variable Cost
B. Variable Cost + Opportunity Cost
C. Full Cost
D. Market Price - Profit
*Ans: B* - Must cover variable cost + lost contribution from outside sale
*11. ROI = 15%, RRR = 10%, Invested Capital = $1,000,000. RI = ?*
A. $50,000
B. $100,000
C. $150,000
D. $250,000
*Ans: A* - `RI = $1,000,000×15% - $1,000,000×10% = $150,000 - $100,000 = $50,000`
*12. Goal congruence means:*
A. Managers and org have same objectives
B. ROI is high
C. Transfer price is low
D. Costs are minimized
*Ans: A* - Key objective of performance measurement
*13. Conflict of interest in transfer pricing occurs when:*
A. Market price is used
B. Cost-based price causes buying division to buy outside at higher cost
C. Both divisions are cost centers
D. No transfer occurs
*Ans: B* - Hurts overall company profit
*14. Which is NOT a benefit of decentralization?*
A. Faster decisions
B. Better motivation
C. Goal congruence always achieved
D. Training ground for managers
*Ans: C* - ROI can cause sub-optimization, hurting goal congruence
*15. Margin in ROI formula =*
A. Sales / Invested Capital
B. Net Income / Sales
C. Net Income / Invested Capital
D. Contribution / Fixed Cost
*Ans: B* - `ROI = Margin × Turnover`
*16. Turnover in ROI formula =*
A. Sales / Invested Capital
B. Net Income / Sales
C. Sales / Fixed Assets
D. COGS / Inventory
*Ans: A*
*17. A revenue center manager is evaluated on:*
A. Costs
B. Sales/Revenue
C. ROI
D. RI
*Ans: B* - Ex: Marketing dept
*18. Dual transfer pricing means:*
A. One price for both divisions
B. Selling division records at market, buying at cost
C. Two different prices used for selling and buying division
D. Price changes every month
*Ans: C* - Used to achieve goal congruence
*19. The best transfer pricing method for overall company profit is:*
A. Cost-based
B. Negotiated
C. Market-based
D. 50% of Market
*Ans: C* - When competitive market exists
*20. EVA is similar to:*
A. ROI
B. RI
C. Gross Margin
D. Turnover
*Ans: B* - `EVA = NOPAT - (Capital × Cost of Capital)`. Same concept as RI
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*SECTION B: 2 ESSAY QUESTIONS*
*Essay Q1: 15 Marks*
_A company has 2 divisions. Division A ROI = 20%, Division B ROI = 12%. Company RRR = 14%. A new project needs $500,000 and will earn 16% ROI. Discuss how evaluating managers on ROI vs RI will affect the decision to accept the project._
*Model Answer:*
*If evaluated on ROI:*
Division A current ROI 20% > Project 16%. Manager will REJECT to avoid ROI dropping.
Division B current ROI 12% < Project 16%. Manager will ACCEPT to improve ROI.
*Problem*: Project earns 16% which is > RRR 14%. It adds value to company. But Division A rejects it = *Sub-optimization*.
*If evaluated on RI:*
Division A RI increase = $500,000×(16%-14%) = $10,000 increase. Will ACCEPT.
Division B RI increase = $500,000×(16%-14%) = $10,000 increase. Will ACCEPT.
*Conclusion*: RI leads to goal congruence. Managers accept all projects > RRR. ROI can lead to rejection of good projects.
*Essay Q2: 10 Marks*
_Explain 3 methods of transfer pricing and when each is most appropriate._
*Model Answer:*
*1. Market-Based Transfer Price*
Price = External market price.
*Best when*: Perfectly competitive external market exists. Achieves goal congruence and divisional autonomy.
*Disadvantage*: Not possible if no external market.
*2. Cost-Based Transfer Price*
Price = Variable Cost OR Full Cost + Markup.
*Best when*: No external market OR selling division has excess capacity. Simple to calculate.
*Disadvantage*: May lead to poor decisions. Doesn’t reflect market value.
*3. Negotiated Transfer Price*
Price negotiated between buying and selling division managers.
*Best when*: Some external market exists but not perfect. Both managers have info.
*Disadvantage*: Time consuming, may cause conflict.
*Key*: Company goal is to maximize overall profit, not divisional profit.
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*CMA FORMULA CHEAT SHEET*
1. *ROI* = `NOI / Avg Invested Capital` = `Margin × Turnover`
2. *RI* = `NOI - (Avg Invested Capital × RRR)`
3. *Min Transfer Price* = `Variable Cost + Opportunity Cost`
4. *EVA* = `NOPAT - (Capital × WACC)`
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