Answers
Answer-1:
Answer-2:
Yes, Presser’s management probably would have accepted the investment if residual income were used. The investment opportunity would have lowered Presser’s ROI because the expected return (18%) was lower than the division’s historical returns as well as its actual ROI (20%) for the year just ended. Management rejected the investment because bonuses are based in part on the performance measure of ROI. If residual income were used as a performance measure (and as a basis for bonuses), management would accept any and all investments that would increase residual including the investment opportunity rejected in the year just ended.
Answer-3:
Presser must control all items related to profit (revenues and expenses) and investment if it is to be evaluated fairly as an investment center by either the ROI or residual income performance measures. Presser must control all elements of the business except the cost of invested capital, that being controlled by Lawton Industries.
Answer-1(a): Balance end of current year Balance end of previous year Total 12,600,000 12,000,000 (12,600,000 / 1.05) 24,600,000 Average operating assets employed 12,300,000 (24,600,000/2) ROI = Income from operation / Avg.
.
Operating assets employed = 24,600,000 / 12,300,000 = 0.20 or 20% Answer-1(b): Income from operations Minimum return on assets employed Residual income 2,460,000 1,845,000 (12,300,000 < 0.15) 615,000
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