Question

1. 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 25 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 27.10 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 $11,623,500 at November 30, 20x2, a 5 percent increase over the 20x1 year-end balance.

   Keimer Steel Company Operating Statement For the Year Ended November 30, 20x2
   Sales revenue				$25,921,000
   Less expenses:
   Cost of goods sold		$16,330,230
   Administrative expenses		3,773,300
   Selling expenses		2,706,000		22,809,530
   Operating income before income taxes				$3,111,470

   Required:

   1. Calculate the unit contribution for Keimer Steel Company if 1,202,100 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.
   $

Answer 1

(1)-The unit contribution for Keimer Steel Company

Total Contribution margin = Sales – Total variable costs

= Sales – Cost of goods sold – Variable selling expenses

= $25,921,000 - $16,330,230 – [$2,706,000 x 30%]

= $25,921,000 - $16,330,230 – $811,800

= $8,778,970

Therefore, the unit contribution = Total contribution margin / Number of units sold

= $8,778,970 / 1,202,100 units

= $7.30 per unit

(2)(a)-The Pre-tax return on average investment in operating assets employed (ROI)

Average Investment = [($11,623,500 / 1.05) + $11,623,500] / 2

= ($11,070,000 + $11,623,500) / 2

= $22,693,500 / 2

= $11,346,750

Therefore, the Pre-tax return on average investment = [Operating income before income taxes / Average Investment] x 100

= [$3,111,470 / $11,346,750] x 100

= 27.42%

(2)(b)-The Residual income calculated on the basis of average operating assets employed.

Residual income = Operating income before income taxes - [Average investment x Minimum required rate of return]

= $3,111,470 – [$11,346,750 x 27.10%]

= $3,111,470 - $3,074,969.25

= $36,500.75 or

= $36,501