Problem - Gable Ceramics, a division of Kerwin Corporation, has an operating income of $ 63,000 and total assets of $ 360,000. The required rate of return for the company is 9%. The company is evaluating whether it should use return on investment (ROI) or residual income (RI) as a measurement of performance for its division managers.
The manager of Gable Ceramics has the opportunity to undertake a new project that will require an investment of $ 90,000. This investment would earn $ 9,000 for the company.
Requirements -
1. What is the original return on investment (ROI) for Gable Ceramics (before making any additional investment)?
2. What would the ROI be for Gable Ceramics if this investment opportunity were under-taken? Would the manager of the Gable Ceramics division want to make this investment if she were evaluated based on ROI? Why or why not?
3. What is the ROI of the investment opportunity? Would the investment be desirable from the standpoint of Kerwin Corporation? Why or why not?
4. What would the residual income (RI) be for Gable Ceramics if this investment opportunity were to be undertaken? Would the manager of the Gable Ceramics division want to make this investment if she were evaluated based on RI? Why or why not?
5. What is the RI of the investment opportunity? Would the investment be desirable from the standpoint of Kerwin Corporation? Why or why not?
6. Which performance measurement method, ROI or RI, promotes goal congruence? Why?