EXERCISE 1
Performance and ROI versus Residual Income
An investment center in Shellforth Corporation was asked to identify three proposals for its capital. Details of those proposals are:
Capital Budget Proposals
A B C
Capital required . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $80,000 $50,000 $150,000
Annual operating return . . . . . . . . . . . . . . . . . . . . . . . . . . 24,000 16,000 15,000
Shellforth uses residual income to evaluate all capital budgeting projects. Its minimum required return is 12 percent.
a. Assume you are the investment center manager. Which project do you prefer? Why?
b. Assume your investment center's current ROI is 18 percent and that the president of Shellforthis thinking about using ROI for the investment center's evaluation. Would your preferences for the projects listed above change? Why?
EXERCISE 2
Concerns about ROI
Jennifer Baskiter is president and CEO of Plants& More.com , an Internet company that sells plants and flowers. The success of her startup Internet company has motivated her to expand and create two divisions. One division focuses on sales to the general public and the other focuses on business-to-business sales to hotels, restaurants, and other firms that want plants and flowers for their businesses. She is considering using return on investment as a means of evaluating her divisions and their managers. She has hired you as a compensation consultant. What issues or concernswould you raise regarding the use of ROI for evaluating the divisions and their managers?