Question

Warthers Corporation produces auto parts. The company acquires other companies when they are considered a good strategic fit. Several years ago Warthers acquired Landis Company, a supplier of dashboards. Warthers decided to maintain Landis’s separate identity and therefore established the Landis Division as one of its investment centers.
Warthers 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 15 percent.
Landis’s ROI has ranged from 15 percent to 22 percent since it was acquired by Warthers. During the past year, Landis had an investment opportunity that would have yielded an estimated rate of return of 18 percent. Landis’s management decided against the investment because it believed the investment would decrease the division’s overall ROI.
Last year’s income statement for the Landis Division is given below. The division’s operating assets employed were $11,220,000 at the end of the year, which represents a 6 percent increase over the previous year-end balance.



Instructions
1. Compute the following performance measures for the Landis Division:
a. ROI where the investment base is the average operating assets (based on the beginning of the year plus the end of the year assets) divided by two. Break ROI into both capital turnover and return on sales.
b. Residual income.
2. Would management of the Landis 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 your answer.
3.Warthers corporate management is reconsidering the design of its division management compensation package. Consider the five compensation design characteristics discussed in this chapter. Which of those design characteristics are consistent with Warthers’s current compensation arrangement (i.e., based on ROI)? How do you think the compensation package should be restructured?
(CMA,adapted)


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  • CreatedApril 17, 2014
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