Question

The manager of the snack division of Fairfax Industries is evaluated on her division’s return on investment and residual income. The company requires that all divisions generate a minimum return on invested assets of 8 percent. Consistent failure to achieve this minimum target is grounds for the dismissal of a division manager. The annual cash bonus paid to division managers is 1 percent of residual income in excess of $100,000. The snack division’s operating margin for the year was $9.56 million, during which time its average invested capital was $64.994 million.

a. Compute the Snack Division's return on investment and residual income.

b. Will the manager of the Snack Division receive a bonus for her performance? If so, how much will it be?

c. In reporting her investment center’s performance for the past 10 years, the manager of the snack division accounted for the depreciation of her division’s assets by using an accelerated depreciation method allowed for tax purposes. As a result, virtually all of the assets under her control are fully depreciated. Given that the company’s other division managers use straight-line depreciation, is her use of an accelerated method ethical?

Answer 1

a) Computation of Return on investment and ResiduComputational income

Invested capital. - $ 64.994 Million

Operating margin. - $ 9.56 Million

Return on investment - 9.56/64.994 X 100

- 14.71%

Residual income

Desired target. - 8% on invested capital

- 8% on 64.994 M

- 5.20 M

So residual income - Actual return on investment less targeted return on investment

Ie. 9.56 - 5.20 = 4.36 Million

b) calculation of performance bonus Bonus will be 1% of residual income in excess of $100,000 - ie. 0.10 Million

So residual income in excess of $100000 = $4.36 Million less $ 0.10 Million = $ 4.26 Million

So bonus eligible = 1% of $ 4.26 M

= 0.043 Million

C) Reporting accelerated depreciation is not considered ethical. All the division should follow a uniform method of depreciation for comparison of their performance. Otherwise comparison becomes useless.