Question

Kaiser Industries produces tool and die machinery for manufacturers. The company expanded vertically several years ago by acquiring Superior Steel Company, one of its suppliers of alloy steel plates. Kaiser decided to maintain Superior’s separate identity and therefore established the Superior Steel Division as one of its investment centres. Kaiser evaluates its divisions on the basis of ROI. Management bonuses are also based on ROI. All investments in operating assets are expected to earn a minimum required rate of return of 11%. Superior’s ROI has ranged from 14% to 17% since it was acquired by Kaiser. During the past year, Superior had an investment opportunity that would yield an estimated rate of return of 13%. Superior’s management decided against the investment because it believed the invest-ment would decrease the division’s overall ROI.
Last year’s absorption costing income statement for Superior Steel Division follows. The division’s operating assets employed were $6,480,000 at the end of the year, which represents an 8% increase over the previous year-end balance:
Required:
1. Compute the following performance measures for the Superior Steel Division:
a. ROI. (Remember, ROI is based on the average operating assets, computed from the be- ginning-of-year and end-of-year balances.) State ROI in terms of margin and turnover.
b. Residual income.
2. Would the management of Superior Steel Division have been more likely to accept the investment opportunity it had last year if residual income were used as a performance measure instead of ROI? Explain.
3. The Superior Steel Division is a separate investment centre within Kaiser Industries. Identify the items Superior must be free to control if it is to be evaluated fairly by either the ROI or the residual income performance measure.


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  • CreatedJuly 08, 2015
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