Question

Using the data from this module’s Connect Excel Simulation - "Calculation of Return of Investment and Residual Income for Adam Corporation’s Northern Division", compare and contrast how the calculations may have impacted the division manager’s decision regarding accepting or rejecting a new product line. Include discussion of the limits of using ROI vs Residual Income for evaluating performance of the division. Do you think the division manager’s decision to invest would change if his/her bonus was based on company ROI versus Residual Income? What is best for the company as a whole?

Adams Corporation evaluates divisional managers based on ROI. Operating results for the company's Northern Division for last year are given below:

SALES	$27,000,000
Variable expense	16,200,000
Contribution margin	10,800,000
Fixed expenses	8,805,000
Net Operating	1,995,000
Average divisional operating assets	9,500,000

The Northern Division has an opportunity to add a new product line at the beginning of the year as Follows:

Required investment	$2,500,000
Net Operating income	400,000

Adams Corporation's minimum acceptable rate of return 15%

Compute the following:

Northern Division ROI for last year 21%

Northern Division ROI if new product line is added 19.96%

Manager will ACCEPT

Northern Division residual income for last $570,000

Northern Division residual income if the new product line is added $595,000

Manager will ACCEPT

Answer 1

ROI:
			Before	After
			Investment	Investment
Net Operating Income			1995000	2395000
				(1995000+400000)
Divide: Average Operating assets			9500000	12000000
				(9500000+2500000)
ROI			21%	19.96%
(Net Income/ Average Assets)
Residual Income:
			Before	After
			Investment	Investment
Net Operating Income			1995000	2395000
				(1995000+400000)
Divide: Average Operating assets			9500000	12000000
				(9500000+2500000)
Acceptable Rate of return			15%	15%
Target return			1425000	1800000
Residual Return			570000	595000
(Actual income-Target Income)
Req 1.
Northern Division ROI: 21%
Northern Division after investment: 19.96%
Accepted
Req 2.
Northern residual income: 570000
Northern division residual income after investment: 595000
Accepted