Question

Return on Investment Michelle Gutierrez, manager of the Components Division of FX Corp, is considering a new investment for her division. Her division has an investment base of $4,000000 and operating income of $600,000. The new investment of $500,000 supports corporate strategy and is expected to increase operating income by $50,000 next year, an acceptable level of return from a corporate headquarters point of view.

a.) What is the current return on investment (ROI) for the components division?

Answer:

b.) What will the (ROI) be if Michelle undertakes the new investment?

Answer:

c.) Suppose Michelle’s compensation consists of a salary plus a bonus proportional to her divisions ROI. Is Michelle’s new compensation higher with or without the new investment?

Answer:

d.) Suggest changes to FX Corporation’s management that will better align performance evaluation and compensation with corporate goals.

Answer 1

Solution a:

Current ROI = Operating income / Investment base = $600,000 / $4,000,000 = 15%

Solution b:

If Micehelle undertakes new investment then:

Revised net operating income = $600,000 + $50,000 = $650,000

Investment base = $4,000,000 + $500,000 = $4,500,000

Proposed ROI = $650,000 / $4,500,000 = 14.44%

Solution c:

As Michelle’s compensation consists of a salary plus a bonus proportional to her divisions ROI and ROI without investment is higher than ROI with investment. Therefore Michelle’s new compensation higher without new investment.

Solution d:

FX Corporation management should given bonus on the basis of residual income rather than ROI. In such case if any investment in providing ROI higher than minimum required return then division will undertake those investment as it will increase residual income of division. However if bonus is based on ROI then new investment will be undetaken by division only if ROI offered by new investment is higher than existing ROI.