19-42 Calculating Return on Investment (ROI) and Residual Income (RI); Comparing Results Blackwood Industries manufactures die machinery. To meet its expansion needs, it recently (2014) acquired one of its suppliers, Delta Steel. To maintain Deltaâs separate identity, Blackwood reports Deltaâs operations as an investment center. Blackwood monitors all of its investment centers on the basis of return on investment (ROI). Management bonuses are based on ROI, and all investment centers are expected to earn a minimum 10% return before income taxes. Deltaâs ROI has ranged from 14% to 18% since 2014. The company recently had the opportunity for a new investment that would have yielded a 13% ROI. However, division management decided against the investment because it believed that the investment would decrease the divisionâs overall ROI. The 2016 operating statement for Delta follows. The divisionâs operating assets were $16,000,000 at the end of 2016, a 6% increase over the 2015 year-end balance.
DELTA DIVISION
Operating Statement for Year Ended
December 31, 2016 (000s omitted)
Sales $29,500
Cost of goods sold 19,920
Gross profit 9,580
Operating expenses:
Administration $2,808
Selling 4,332 7,140
Operating income $2,440
Required
1. Calculate the following performance measures for 2016 for the Delta division:
a. Return on average investment in operating assets.
b. Residual income (RI) calculated on the basis of average operating assets.
2. Which performance measure (ROI or RI) should Blackwood Industries use to provide the proper incentive for each division to act autonomously in the firmâs best interests? Would Deltaâs management have been more likely to accept the capital investment opportunity if RI had been used as a performance measure instead of ROI? Explain.
3. What type of strategic performance measurement do you recommend for the Delta division? Explain.
19-42 Calculating Return on Investment (ROI) and Residual Income (RI); Comparing Results Blackwood Industries manufactures die machinery. To meet its expansion needs, it recently (2014) acquired one of its suppliers, Delta Steel. To maintain Deltaâs separate identity, Blackwood reports Deltaâs operations as an investment center. Blackwood monitors all of its investment centers on the basis of return on investment (ROI). Management bonuses are based on ROI, and all investment centers are expected to earn a minimum 10% return before income taxes. Deltaâs ROI has ranged from 14% to 18% since 2014. The company recently had the opportunity for a new investment that would have yielded a 13% ROI. However, division management decided against the investment because it believed that the investment would decrease the divisionâs overall ROI. The 2016 operating statement for Delta follows. The divisionâs operating assets were $16,000,000 at the end of 2016, a 6% increase over the 2015 year-end balance.
DELTA DIVISION
Operating Statement for Year Ended
December 31, 2016 (000s omitted)
Sales $29,500
Cost of goods sold 19,920
Gross profit 9,580
Operating expenses:
Administration $2,808
Selling 4,332 7,140
Operating income $2,440
Required
1. Calculate the following performance measures for 2016 for the Delta division:
a. Return on average investment in operating assets.
b. Residual income (RI) calculated on the basis of average operating assets.
2. Which performance measure (ROI or RI) should Blackwood Industries use to provide the proper incentive for each division to act autonomously in the firmâs best interests? Would Deltaâs management have been more likely to accept the capital investment opportunity if RI had been used as a performance measure instead of ROI? Explain.
3. What type of strategic performance measurement do you recommend for the Delta division? Explain.
Related questions
Exercise 13-29 ROI; Residual Income (LO 13-1, 13-2)
[The following information applies to the questions displayed below.]
Wyalusing Industries has manufactured prefabricated houses for over 20 years. The houses are constructed in sections to be assembled on customersâ lots. Wyalusing expanded into the precut housing market when it acquired Fairmont Company, one of its suppliers. In this market, various types of lumber are precut into the appropriate lengths, banded into packages, and shipped to customersâ lots for assembly. Wyalusing designated the Fairmont Division as an investment center. Wyalusing uses return on investment (ROI) as a performance measure with investment defined as average productive assets. Management bonuses are based in part on ROI. All investments are expected to earn a minimum return of 14 percent before income taxes. Fairmontâs ROI has ranged from 19.3 to 22.5 percent since it was acquired. Fairmont had an investment opportunity in 20x1 that had an estimated ROI of 18 percent. Fairmontâs management decided against the investment because it believed the investment would decrease the divisionâs overall ROI. The 20x1 income statement for Fairmont Division follows. The divisionâs productive assets were $37,800,000 at the end of 20x1, a 5 percent increase over the balance at the beginning of the year.
| FAIRMONT DIVISION | ||||||
| Income Statement | ||||||
| For the Year Ended December 31, 20x1 | ||||||
| (in thousands) | ||||||
| Sales revenue | $ | 63,760 | ||||
| Cost of goods sold | 36,100 | |||||
| Gross margin | $ | 27,660 | ||||
| Operating expenses: | ||||||
| Administrative | $ | 4,730 | ||||
| Selling | 15,550 | 20,280 | ||||
| Income from operations before income taxes | $ | 7,380 | ||||
Required:
1-a. Calculate the return on investment (ROI) for 20x1 for the Fairmont Division.
1-b. Calculate residual income for 20x1 for the Fairmont Division.
