Accounting Case Essay
Kitchen Appliances Inc. is a multi-division company with each major product-line managed by a separate division. Divisional managers have complete autonomy with respect to operating and investment decisions. The company evaluates its division managers on ROI, calculated as operating income before taxes (for that year) divided by net book value of assets (at the beginning of that year). The firm pays particular attention to year-over-year growth in ROI as well as budget-actual comparison of the measure.
Wendy Miller is the manager of the dishwasher division. Wendy expects that the operating income for the current year will be $2,400,000 before taxes. Given a net asset base of $6,800,000, the division’s ROI would be a …show more content…
Since Residual income represents the additional profit generated by an investment after meeting the required rate of return. It does not lead to underinvestment because this project has a positive NPV so it will have a positive residual income. Since RI depends on the size of the investment and the % of rate of return, it gives a different ranking compared to the ROI.
Mary is the Manager of the backpack division of a manufacturing company that specializes in sports equipment. In the last few years, Mary had some problems finding good projects to invest in. She is evaluated on the ROI of her division, and last year she obtained a ROI of 10%. Mary knows that if she does not improve the ROI of her division she will not receive a bonus and her quality as a manager will be questioned.
Mary held a meeting with her functional managers and, together, they came up with two projects, the LighPack and the SpeedPack. The controller of the division was happy because both projects seemed profitable and thought that they should be both undertaken. However, Mary was not so sure about that.
a) The following data allowed the controller to calculate the NPV