Ch6 Verified Test Bank Return On Invested Capital

Chapter: Chapter 06: Return on Invested Capital

Multiple Choice

1. Which of the following is NOT one of Michael Porter’s five forces?

a) Threat of entry.

b) Regulatory restrictions.

c) Bargaining power of buyers.

d) Bargaining power of suppliers.

Response: []

2. Which of the following industries is most likely to have the lowest ROIC (where goodwill has been removed)?

a) Software.

b) IT services.

c) Pharmaceuticals.

d) Paper packaging.

Response: [Paper packaging offers the lowest opportunity for branding and has low barriers to entry.]

3. A firm’s additional costs for producing each additional unit of its product are essentially zero. The best term for describing the firm’s product is that it is:

a) A Giffen good.

b) A normal good.

c) A scalable product.

d) An inferior good.

Response: []

4. Given that a company charges $10 per unit, has a cost per unit of $9.10 and a tax rate of 28 percent, and requires $4.50 of invested capital per unit, what is the ROIC?

a) 3.82 percent.

b) 5.18 percent.

c) 9.44 percent.

d) 14.40 percent.

Response: [ROIC = (1 – 0.28) * (10 – 9.1)/4.5 = 0.144 or 14.4%]

5. Given that a company charges $3.40 per unit, has a cost per unit of $1.80 and a tax rate of 32 percent, and requires $16 of invested capital per unit, what is the ROIC?

a) 6.8 percent.

b) 10.2 percent.

c) 15.6 percent.

d) 30.3 percent.

Response: [ROIC = (1 – 0.32) * (3.40 – 1.80)/16 = 0.068 or 6.8%]

6. Which of the following are sources of competitive advantage that allow a firm to charge a price premium?

I. Quality.

II. Customer lock-in.

III. Innovative products.

IV. Rational price discipline.

a) I and II only.

b) I, III, and IV only.

c) II and III only.

d) I, II, III, and IV.

Response: []

7. Which of the following are strategies that will most likely support a sustainable ROIC?

I. Extend life cycles of products and services.

II. Offer generic products.

III. Implement a temporary cost-reduction program.

IV. Use established brands to launch new products.

a) I and IV only.

b) I, III, and IV only.

c) II and III only.

d) I, II, III, and IV.

Response: []

8. Cereal manufacturers have been successful at branding their products, while meat producers have been unable to do so to a large degree. Based on this fact, which of the following is the most accurate concerning the pricing advantage that cereal manufacturers have over meat producers?

a) The ROIC for cereal manufactures is less than that of meat producers because branding does not create value and branding has a cost.

b) The ROIC for cereal manufactures is equal to that of meat producers because the costs and benefits reach an equilibrium.

c) The ROIC for cereal manufactures is twice as high as that of meat producers.

d) The ROIC for cereal manufactures is three times as high as that of meat producers.

Response: [For cereal manufacturers and meat producers, the ROICs are 30 percent and 15 percent, respectively. Cereal manufacturers earn a higher return as a result of being able to brand their products.]

True/False

9. ROICs tend to be mean reverting, but firms tend to sustain their relative position to the mean (i.e., either higher or lower) for 10 years or more.

Response: []

10. Historically, the rates of growth of firms tend to be more stable than their ROICs.

Response: [Growth rates are less stable than ROICs.]

11. Compared to industries where firms produce generic products, firms in industries where they can brand their products generally earn higher ROICs.

Response: []

12. Cost efficiencies offer any business the greatest scope for achieving an attractive ROIC, but they are usually more difficult to achieve than price premiums.

Response: [Price premiums offer any business the greatest scope for achieving an attractive ROIC, but they are usually more difficult to achieve than cost efficiencies.]

13. Certain industries are biased toward earning either high, medium, or low returns, but there is still significant variation in the rates of return for individual companies within each industry.

Response: []

14. Both ROIC including goodwill and ROIC excluding goodwill have been increasing at a similar rate.

Response: [While returns on invested capital without goodwill have been increasing,

returns on invested capital with goodwill have been relatively stable. This suggests that acquiring companies haven’t been able to extract much value from their acquisitions.]

15. Competitive advantages based on brands, as in the consumer goods industry, are often more important for long-term value creation than advantages based on product quality or innovation.

Response: [Within consumer goods, innovation and quality are important, but competitive advantages for products are based more on differentiation than on durability. Branding is a vital part to show differentiation and product traits, so by improving branding a relationship with the customer is created, and in the long term this increases ROIC.]

16. Within the broader health care sector, ROIC can be declining for health-care facility companies but increasing for health-care equipment companies.

Response: [Health-care facility companies have had to deal with increasing government regulation, insurance companies, and competition from nonprofit organizations. They also suffer from the higher prices that health-care equipment companies can charge for their patented equipment. The patents are the source of the high ROIC of the equipment companies.]

Short Answer

17. List and briefly explain the five sources of price premiums.

2. Quality means a real or perceived difference between one product or service and competitors, for which consumers are willing to pay a higher price.

3. Branding is similar to quality, and the premiums would be highly correlated. After a product has been established, brand may count more than quality in the ability to charge a price premium.

4. Customer lock-in refers to making it costly for customers to replace the product a company sells with the product of another company.

5. Rational price discipline can allow for premiums if the sellers can discipline themselves to not compete prices down. Usually there has to be a barrier to entry to the industry to allow this.]