Residual income PROBLEM 12-4 Comparing Performance Using ROI LO2- CC4, 6] Guenth

Question

Residual income PROBLEM 12-4 Comparing Performance Using ROI LO2- CC4, 6] Guenther Corporation uses the return on investment (ROI) measure to evaluate its managers. A summary of the performance of two divisions is given below: CHECK FIGURE (1) Division A ROI 20%; Division B ROI 18% Division A $240,000 48,000 Division B $400,000 72,000 verage operating assets Net income The minimum required return on operating assets for Guenther Corporation is 14% Required According to Guenther's senior management, which division is the better performer? Why? measure affect management's evaluation of the two divisions? assets by $100,000 and increase profit by $15,000 1. 2. Can Guenther's management use a different measure to evaluate performance? How wll using a different 3. Suppose the manager of Division A were offered a one-year project that would increase his average operating a. Would the manager accept the project under the current method of performance evaluation? Why, or why b. Using your alternative measure of performance evaluation (as in part (2) above), do you think the 4. Comment on the value of using only financial metrics to evaluate performance. Is there any other performance not manager should accept the project? Why, or why not? measurement model available that provides a more holistic view of an organization's performance? Explain this performance measurement model in detail e celPROBLEM 12-5 Computing ROl and RI [LO2- CC4, 6

Explanation / Answer

Assets

Margin

ROI

Division A

2,40,000

     48,000

20%

Division B

4,00,000

     72,000

18%

b. If we see in absolute term the division B performance is still higher i.e. 72,000> 63,000

Assets

Margin

ROI

Division A

2,40,000

     48,000

20%

Division B

4,00,000

     72,000

18%

1. 1. Since ROI in Division A is 20% which is better than the ROI of Division B, SO Division A is better performer

1. 2Another method of evaluation of the performance of the division is to measure the profit in absolute term instead of relative term, if we see in absolute term than division B is earning hire profit that is 72,000 as compare to Division A which is earning lower profit i.e. 48,000 only since both the division are earning the higher from the minimum required rate of return i.e. 14%.

1. a. If additional increase in profit of 15000 by putting additional 100,000 will give Additional ROI of 15% and in Total ROI of Division A will be (48000+15000)/(240000+100000) 18.52% Which is higher than the minimum required rate of return of the organisation so it should be accepted.

b. If we see in absolute term the division B performance is still higher i.e. 72,000> 63,000

1. Yes, there are other methods like analysis the variance of each division what target is there in the budget of each division how much they have achieved

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