Problem:
Raddington Industries produces tool and die machinery for manufacturers. The company expanded vertically in 1993 by acquiring one of its suppliers of alloy steel plates, Reigis Steel Company. To manage the two separate businesses, the operations of Reigis are reported separately as an investment center. Raddington monitors its divisions on the basis of both unit contribution and return on average investment (ROI), with investment defined as average operating assets employed. Management bonuses are determined based on ROI. All investments in operating assets are expected to earn a minimum return of 11 percent before income taxes. Reigis's cost of goods sold is considered to be entirely variable, whereas the division's administrative expenses are not dependent on volume. Selling expenses are a mixed cost with 40 percent attributed to sales volume. Reigis's ROI has ranged from 11.8 percent to 14.7 percent since 1993. During the fiscal year ended November 30, 2000, Reigis contemplated a capital acquisition with an estimated ROI of 11.5 percent; however, division management decided that the investment would decrease Reigis's overall ROI. The 2000 income statement for Reigis follows. The division's operating assets employed were $15,750,000 at November 30, 2000, a 5 percent increase over the 1999 year-end balance.
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Sales revenue
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$25,000
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Less expenses:
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Cost of goods sold
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$16,500
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Administrative expenses
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3,955
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Selling expenses
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2,700
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-23,155
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Income from operations before income taxes
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$1,845
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a. Calculate the segment contribution for Reigis Steel Division if 1,484,000 units were produced and sold during the year ended November 30, 2000.
b. Calculate the following performance measures for 2000 for the Reigis Steel Division:
1. pretax return on average investment in operating assets employed (ROI), And
2. residual income calculated on the basis of average operating assets employed.
c. Explain why the management of the Reigis Steel Division would have been more likely to accept the contemplated capital acquisition if residual income rather than ROI were used as a performance measure.
d. The Reigis Steel Division is a separate investment center within Raddington Industries. Identify several items that Reigis should control if it is to be evaluated fairly by either the ROI or residual income performance measures. (CMA adapted)