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Solutions To Cases
Solutions To Cases
1. If New Age Industries continued to use return on investment as the sole measure of
division performance, Holiday Entertainment Corporation (HEC) would be reluctant
to acquire Recreational Leasing, Inc. (RLI), because the post-acquisition combined
ROI would decrease.
Return on Investment
HEC RLI Combined
Operating income..........................................$2,000,000 $ 600,000 $
2,600,000
Total assets................................................... 8,000,000 3,000,000 11,000,000
Return on investment (income/assets)............ 25% 20% 23.6%*
*Rounded.
The result would be that HEC's management would either lose their bonuses or
have their bonuses limited to 50 percent of the eligible amounts. The assumption is
that management could provide convincing explanations for the decline in return on
investment.
2. Residual income is the profit earned that exceeds an amount charged for funds
committed to a business unit. The amount charged for funds is equal to an imputed
interest rate multiplied by the business unit's invested capital.
Residual Income
HEC RLI Combined
Total assets............................................ $8,000,000 $3,200,000* $11,200,00
0
Income................................................... $2,000,000 $ 600,000 $
2,600,000
Less: Imputed interest charge
(assets 15%).................................... 1,200,000 480,000
1,680,000
Residual income..................................... $ 800,000 $ 120,000 $
920,000
*Cost to acquire RLI.
CASE 13-50 (CONTINUED)
Shy away from profitable opportunities or investments that would yield more
than the company's cost of capital but that could lower ROI.