In: Accounting
ROI, Residual Income
Raddington Industries produces tool and die machinery for manufacturers. The company expanded vertically in 20x1 by acquiring one of its suppliers of alloy steel plates, Keimer Steel Company. To manage the two separate businesses, the operations of Keimer are reported separately as an investment center.
Raddington monitors its divisions on the basis of both unit contribution and return on average investment (ROI), with investment defined as average operating assets employed. Management bonuses are determined on ROI. All investments in operating assets are expected to earn a minimum return of 21 percent before income taxes.
Keimer's cost of goods sold is considered to be entirely variable, while the division's administrative expenses are not dependent on volume. Selling expenses are a mixed cost with 30 percent attributed to sales volume. Keimer contemplated a capital acquisition with an estimated ROI of 22.90 percent; however, division management decided against the investment because it believed that the investment would decrease Keimer's overall ROI.
The 20x2 operating statement for Keimer follows. The division's operating assets employed were $12,105,200 at November 30, 20x2, a 6 percent increase over the 20x1 year-end balance.
Keimer Steel Company Operating Statement For the Year Ended November 30, 20x2 |
||||
Sales revenue | $25,133,000 | |||
Less expenses: | ||||
Cost of goods sold | $15,582,460 | |||
Administrative expenses | 4,153,900 | |||
Selling expenses | 2,646,000 | 22,382,360 | ||
Operating income before income taxes | $2,750,640 |
Required:
1. Calculate the unit contribution for Keimer
Steel Company if 1,220,700 units were produced and sold during the
year ended November 30, 20x2. Round your answer to the nearest
cent.
$ per unit
2. Calculate the following performance measures for 20x2 for Keimer Steel Company:
a. Pretax return on average investment in operating assets
employed (ROI). Round your percentage answer to two decimal places
(for example, the decimal .10555 would be entered as "10.56"
percent).
%
b. Residual income calculated on the basis of average operating
assets employed.
$
3. Explain why the management of Keimer Steel
Company would have been more likely to accept the contemplated
capital acquisition if residual income rather than ROI were used as
a performance measure.
4. Keimer Steel Company is a separate investment center within Raddington Industries. Identify several items that Keimer should control if it is to be evaluated fairly by either the ROI or residual income performance measures. (CMA adapted)