Problem 9-22B Return on investment and residual income Roswell Company has opera

Question

Problem 9-22B Return on investment and residual income

Roswell Company has operating assets of $8,000,000. The company’s operating income for the most recent accounting period was $600,000. The Lawrence Division of Roswell controls $1,600,000 of the company’s assets and earned $144,000 of its operating income. Roswell’s desired ROI is 7 percent. Roswell has $600,000 of additional funds to invest. The manager of the Lawrence Division believes that his division could earn $50,400 on the additional funds. The highest investment opportunity to any of the company’s other divisions is 8 percent.

Required

If ROI is used as the sole performance measure, would the manager of the Lawrence Division be likely to accept or reject the additional funding? Why or why not?

Would Roswell Company benefit if the manager of the Lawrence Division accepted the additional funds? Why or why not? Round your percentages to one decimal point.

If residual income is used as the sole performance measure, would the manager of the Lawrence Division be likely to accept or reject the additional funding? Why or why not?

Explanation / Answer

ROI of Lawrence division = 144000 / 1600000 = 0.09 or 9%
1). If ROI is used as the sole performance measure, it is likely for the manager of the lawrence division to accept the additional funding because the lawrence division has higher ROI then any of the other divisions, further it is believed that this division could earn $50400 i.e 8.4% (50400 / 600000) on additional funds which is still higher than other units expected return which is 8%.

2). Yes, Roswell company benefit if the manager of lawrence division accepts the additional funds because it is earning return on these additional funds higher than the any other divisions . Return expected is 8.4% which is higher than highest investment oportunity to any of the company's other divisions i.e 8%. Net benefit 0.4%

3). If residual income is used as the sole performance measure, it is still likely for the manager of lawrence division to accept the additonal funding. Here the desired ROI is 7%, while the highest investment oportunity to any of the company's other divisions i.e 8% and the lawrence division is earning 9%, here other divisions are earning residual income of 1% while lawrence division earning 2% residual income. Hence it is beneficial for the divisiona and also for the company.

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