PROBLEM 9–14B Return on Investment (ROI) and Residual Income [LO1 , LO2]

CHECK FIGURE
(1) Total ROI: 28.63%

“I know headquarters wants us to add that new product line,” said Brian Stettler, manager of
Sparks Products’ Central Division. “But I want to see the numbers before I make a move. Our
division’s return on investment (ROI) has led the company for three years, and I don’t want any
letdown.” Sparks Products is a decentralized wholesaler with four autonomous divisions. The
divisions are evaluated on the basis of ROI, with year-end bonuses given to divisional managers
who have the highest ROI. Operating results for the company’s Central Division for last year are
given below:

Sales .................................................. $22,000,000

Variable expenses ............................... 14,000,000
Contribution margin ............................ 8,000,000
Fixed expenses ................................... 6,174,000
Net operating income .......................... $ 1,826,000
Divisional operating assets .................. $ 5,500,000

The company had an overall ROI of 18% last year (considering all divisions). The company’s
Central Division has an opportunity to add a new product line that would require an investment
of $3,430,000. The cost and revenue characteristics of the new product line per year would be
as follows:

Sales ................................... $ 10,290,000

Variable expenses ................ 65% of sales
Fixed expenses ..................... $ 2,870,910

Required:
1. Compute the Central Division’s ROI for last year; also compute the ROI as it would appear if
the new product line is added.
2. If you were in Brian Stettler’s position, would you accept or reject the new product line?
Explain.
3. Why do you suppose headquarters is anxious for the Central Division to add the new product
line?
4. Suppose that the company’s minimum required rate of return on operating assets is 15%
and that performance is evaluated using residual income.
a. Compute the Central Division’s residual income for last year; also compute the residual
income as it would appear if the new product line is added.
b. Under these circumstances, if you were in Brian Stettler‘s position would you accept or
reject the new product line? Explain.

© The McGraw-Hill Companies, Inc., 2013. All rights reserved.

Chapter 9 Alternate Problems 9-1
PROBLEM 9–15B Comparison of Performance Using Return on Investment (ROI)
[LO1]
CHECK FIGURE
(2) Company Z return on investment: 12%

Comparative data on three companies in the same service industry are given below:

Company
X Y Z
Sales ........................................... $3,910,000 $1,390,000 $ ?
Net operating income ................... $ 664,700 $ 180,700 $ ?
Average operating assets .............. $1,700,000 ? $2,640,000
Margin ......................................... ? ? 5%
Turnover ...................................... ? ? 2.40
Return on investment (ROI) .......... ? 6.50 % ?

Required:
1. What advantages are there to breaking down the ROI computation into two separate
elements, margin and turnover?
2. Fill in the missing information above, and comment on the relative performance of the three
companies in as much detail as the data permit. Make specific recommendations about how
to improve the ROI.

(Adapted from National Association of Accountants, Research Report No. 35, p. 34)

© The McGraw-Hill Companies, Inc., 2013. All rights reserved.

9-2 Introduction to Managerial Accounting, 6th edition
PROBLEM 9–16B Measures of Internal Business Process Performance [LO3]
CHECK FIGURE
(1a) MCE month 1: 10.9%;
(3a) MCE month 5: 42.9%

Bauer Fabrications, Ltd., of Edinburg, Scotland, has recently begun a continuous improvement
campaign in conjunction with a move toward Lean Production. Management has developed new
performance measures as part of this campaign. The following operating data have been
gathered over the last four months:

Month
1 2 3 4
Throughput time ............................. ? ? ? ?
Manufacturing cycle efficiency .......... ? ? ? ?
Delivery cycle time .......................... ? ? ? ?
Percentage of on-time deliveries ...... 79% 80% 85% 92%
Total sales (units) ........................... 10,410 10,590 10,530 10,420

Management would like to know the company’s throughput time, manufacturing cycle
efficiency, and delivery cycle time. The data to compute these measures have been gathered
and appear below:

Month
1 2 3 4
Move time per unit, in days .............. 0.5 0.7 0.5 0.3
Process time per unit, in days ………... 0.5 0.8 0.7 0.6
Wait time per order before start of
production, in days........................... 9.7 8.0 5.0 4.0
Queue time per unit, in days……….... 3.0 3.0 2.0 1.0
Inspection time per unit, in days ...... 0.6 0.7 0.5 0.5

Required:
1. For each month, compute the following:
a. The throughput time.
b. The manufacturing cycle efficiency (MCE).
c. The delivery cycle time.
2. Using the performance measures given in the problem and those you computed in (1)
above, identify whether the trend over the four months is generally favorable, generally
unfavorable, or mixed. What areas apparently require improvement and how might they be
improved?
3. Refer to the move time, process time, and so forth, given for month 4.
a. Assume that in month 5 the move time, process time, and so forth, are the same as for
month 4, except that through the implementation of Lean Production, the company is
able to completely eliminate the queue time during production. Compute the new
throughput time and MCE.
b. Assume that in month 6 the move time, process time, and so forth, are the same as for
month 4, except that the company is able to completely eliminate both the queue time
during production and the inspection time. Compute the new throughput time and MCE.

© The McGraw-Hill Companies, Inc., 2013. All rights reserved.

Chapter 9 Alternate Problems 9-3
PROBLEM 9-17B Building a Balanced Scorecard (LO4)
An alternate problem does not exist.

© The McGraw-Hill Companies, Inc., 2013. All rights reserved.

9-4 Introduction to Managerial Accounting, 6th edition
PROBLEM 9–18B Return on Investment (ROI) and Residual Income [LO1 , LO2]
CHECK FIGURE
(1) ROI: 33%

Financial data for Stirling, Inc., for last year are as follows:

Stirling, Inc.
Balance Sheet

Beginning Ending
Balance Balance
Assets
Cash ....................................................... $ 139,000 $ 136,000
Accounts receivable ................................. 334,000 478,000
Inventory ................................................ 563,000 478,000
Plant and equipment, net ......................... 874,000 858,000
Investment in Brier Company ................... 405,000 429,000
Land (undeveloped) ................................ 246,000 250,000
Total assets ............................................ $2,561,000 $2,629,000
Liabilities and Stockholders’ Equity
Accounts payable .................................... $ 381,000 $ 339,000
Long-term debt ....................................... 974,000 974,000
Stockholders’ equity ................................ 1,206,000 1,316,000
Total liabilities and stockholders’ equity .... $2,561,000 $2,629,000

Stirling, Inc.
Income Statement

Sales ................................... $5,404,000

Operating expenses .............. 4,755,520
Net operating income ........... 648,480
Interest and taxes:
Interest expense .............. $130,000
Tax expense .................... 192,000 322,000
Net income .......................... $326,480

The company paid dividends of $216,480 last year. The “Investment in Brier Company” on the
balance sheet represents an investment in the stock of another company.

Required:
1. Compute the company’s margin, turnover, and return on investment (ROI) for last year.
2. The board of directors of Stirling, Inc., has set a minimum required return of 15%. What was
the company’s residual income last year?

© The McGraw-Hill Companies, Inc., 2013. All rights reserved.

Chapter 9 Alternate Problems 9-5
PROBLEM 9–19B Perverse Effects of Some Performance Measures (LO4)
An alternate problem does not exist.

© The McGraw-Hill Companies, Inc., 2013. All rights reserved.

9-6 Introduction to Managerial Accounting, 6th edition
PROBLEM 9–20B Return on Investment (ROI) Analysis [LO1]
CHECK FIGURE
(3) ROI: 18.91%
(6) ROI: 24.27%

The contribution format income statement for Strickland, Inc., for its most recent period is
given below:

Total Unit
Sales ........................................ $990,000 $49.50
Variable expenses ..................... 594,000 29.70
Contribution margin .................. 396,000 19.80
Fixed expenses ......................... 318,000 15.90
Net operating income ................ 78,000 3.90
Income taxes @40% ................. 31,200 1.56
Net income ................................ $46,800 $2.34

The company had average operating assets of $503,000 during the period.

Required:
1. Compute the company’s return on investment (ROI) for the period using the ROI formula
stated in terms of margin and turnover.
For each of the following questions, indicate whether the margin and turnover will increase,
decrease, or remain unchanged as a result of the events described, and then compute the new
ROI figure. Consider each question separately, starting in each case from the original ROI
computed in (1) above.
2. The company achieves a cost savings of $6,000 per period by using less costly materials.
3. Using Lean Production, the company is able to reduce the average level of inventory by
$91,000. (The released funds are used to pay off bank loans.)
4. Sales are increased by $198,000; operating assets remain unchanged.
5. The company issues bonds and uses the proceeds to purchase $128,000 in machinery and
equipment at the beginning of the period. Interest on the bonds is $14,000 per period. Sales
remain unchanged. The new, more efficient equipment reduces production costs by $5,000
per period.
6. The company invests $182,000 of cash (received on accounts receivable) in a plot of land
that is to be held for possible future use as a plant site.
7. Obsolete inventory carried on the books at a cost of $17,000 is scrapped and written off as a
loss.

© The McGraw-Hill Companies, Inc., 2013. All rights reserved.

Chapter 9 Alternate Problems 9-7
PROBLEM 9–21B Creating Balanced Scorecards that Support Different Strategies
(LO4)
An alternate problem does not exist.

© The McGraw-Hill Companies, Inc., 2013. All rights reserved.

9-8 Introduction to Managerial Accounting, 6th edition
PROBLEM 9–22B Internal Business Process Performance Measures [LO3]
CHECK FIGURE
(1) MCE month 1: 78%;
(3a) MCE month 5: 21.4%

Inverness Corporation has recently begun a continuous improvement campaign. As a

consequence, there have been many changes in operating procedures. Progress has been slow,
particularly in trying to develop new performance measures for the factory.

Management has been gathering the following data over the past four months:

Month
1 2 3 4
Quality control measures:
Customer complaints as a percentage of units sold .... 1.0% 1.0% 1.0% 1.1%
Warranty claims as a percentage of units sold............. 1.8% 1.8% 1.8% 1.8%
Defects as a percentage of units produced ................. 4.3% 3.9% 3.5% 3.0%
Material control measures:
Scrap as a percentage of total cost ............................ 3.0% 2.7% 2.8% 2.5%
Machine performance measures:
Percentage of machine availability ............................. 80% 79% 81% 80%
Use as a percentage of availability ............................. 73% 76% 71% 71%
Average setup time (hours) ....................................... 2.3% 2.3% 2.3% 2.3%
Delivery performance measures:
Throughput time ...................................................... ? ? ? ?
Manufacturing cycle efficiency ................................... ? ? ? ?
Delivery cycle time ................................................... ? ? ? ?
Percentage of on-time deliveries ............................... 86% 88% 93% 95%

The president has attended conferences at which the importance of throughput time,
manufacturing cycle efficiency, and delivery cycle time were stressed, but no one at the
company is sure how they are computed. The data to compute these measures have been
gathered and appear below:

Month
1 2 3 4
Wait time per order before start of production, in days .... 15.6 14.5 11.8 9.0
Inspection time per unit, in days .................................... .1 .1 .5 .6
Process time per unit, in days ........................................ .5 .5 .5 .5
Queue time per unit, in days ......................................... 5.6 5.7 5.6 5.7
Move time per unit, in days ............................................ 1.4 1.3 1.3 1.4

Required:
1. For each month, compute the following operating performance measures:
a. Throughput time.
b. Manufacturing cycle efficiency (MCE).
c. Delivery cycle time.

© The McGraw-Hill Companies, Inc., 2013. All rights reserved.

Chapter 9 Alternate Problems 9-9
2. Using the performance measures given in the problem and those you computed in (1)
above, do the following:
a Identify areas where the company seems to be improving.
b. Identify areas where the company seems to be deteriorating or stagnating.
c. Explain why you think some specific areas are improving while others are not.
3. Refer to the move time, process time, and so forth, given above for month 4.
a. Assume that in month 5 the move time, process time, and so forth, are the same as for
month 4, except that through the implementation of Lean Production, the company is
able to completely eliminate the queue time during production. Compute the new
throughput time and MCE.
b. Assume that in month 6 the move time, process time, and so forth, are the same as for
month 4, except that the company is able to completely eliminate both the queue time
during production and the inspection time. Compute the new throughput time and MCE.

© The McGraw-Hill Companies, Inc., 2013. All rights reserved.

9-10 Introduction to Managerial Accounting, 6th edition