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59) Managerial Financial Accounting Assignments AP12-18 Solution

59) Managerial Financial Accounting Assignments AP12-18 Solution

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AP12-18 Comparing Performance Evaluation Methods [LO 4,5,6] Top management of the Gates Corporation is trying to construct a performance evaluation system to use to evaluate each of its three divisions. This past year’s financial data are as follows: Division A Division B Division C Total assets $550,000 $10,900,00 0 $6,030,000 Noninterest-bearing current liabilities 28,200 1,210,000 560,000 Net income 103,000 1,040,000 760,000 Interest expense 30,800 1,010,000 710,000 Tax rate 40% 40% 40% Required rate of return 9.70% 11.90% 15.60%
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How would the divisions be ranked (from best to worst performance) if the evaluation were based on net income? Net Income Rank Division A $[no answer] Rank 3 Division B $[no answer] Rank 1 Division C $[no answer] Rank 2 AP12-18 Division A Division B Division C Net income $ 103,000 $ 1,040,000 $ 760,000 Division B has the highest net income, followed by Division C and then Division A . An advantage of rewarding managers based on net income is that managers are clearly motivated to increase profitability of the firm. But a disadvantage is that evaluation in terms of profit can lead managers to make investments that earn a return less than the cost of capital. Hence, they may overinvest in assets.
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