(8 marks; suggested time 10 minutes)
“In the midst of all of the scandals and mistrust of accounting, it is nice to have a basic tool
such as a budget so that a company can always get an accurate assessment of how it is
Provide a thoughtful response. Identify and fully discuss two ideas.
(18 marks, suggested time 22 minutes)
ROI and Residual Income
The Montross Corporation is organized into three separate divisions.
Each division manager is
responsible for controlling working capital and net fixed assets.
Currently, the company
evaluates managers based on return on investment.
Information for each of the three divisions
is as follows:
Average Current assets
Average Net fixed assets
The minimum required rate of return is 10%.
a. Which division is performing best based on return on investment?
b. Which division is performing best based on residual income?
c. When calculating either ROI or RI, operating income (EBIT) is used as the starting figure
for determining the measure of income. If a division is to
be evaluated fairly by either the
ROI or residual income performance measures, why should
operating income (EBIT) be
used as the basis for the income measure.
d. Residual income is sometimes called EVA (Economic Value Added) or wealth creation.
How is wealth creation different from earning net income? Which is more essential to the
company in the long run?
Fully explain your conclusion.
(23 marks; suggested time 30 minutes)
"Rats! We're still in the red," said Bugs Bunny, executive vice president of Cartoons Company
"I know," said Daffy Duck, the controller.
"Just look at this income statement for
March (a typical month).
We don't need to worry at all about East District; but, we've really got
to shake things up in West District."
The statement to which Daffy Duck was referring is shown
Sales ($20 per unit)