Accounting Case Essay

1245 Words May 7th, 2013 5 Pages
Problem 12.61

Kitchen Appliances Inc. is a multi-division company with each major product-line managed by a separate division. Divisional managers have complete autonomy with respect to operating and investment decisions. The company evaluates its division managers on ROI, calculated as operating income before taxes (for that year) divided by net book value of assets (at the beginning of that year). The firm pays particular attention to year-over-year growth in ROI as well as budget-actual comparison of the measure.

Wendy Miller is the manager of the dishwasher division. Wendy expects that the operating income for the current year will be $2,400,000 before taxes. Given a net asset base of $6,800,000, the division’s ROI would be a
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a. Will Wendy accept the project? Make a recommendation after calculating her ROI with and without the investment. Assume that investment occurs at the start of the year.

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Comparing it in 3rd year
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Though in the first year of investment, Wendy’s ROI after investment will be 34.36% based on which she should reject the project.

But from the second year onwards it will start growing. If she decides to stay with the company longer, this new investment makes sense for Wendy in the long run (after 1 year) and it is not affecting her presently as well.

No, Wendy will reject the project given the first year’s ROI.

b. Assume that the company evaluates its divisional managers based on residual income, using a 12% required rate of return. What is the dishwasher division’s expected residual income for the current year (without the proposed investment)? What is the dishwasher division’s expected residual income for the current year with the proposed project?

The dishwasher division’s expected residual income for the current year (without the proposed investment) is $1,584,000 given as follows:

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The dishwasher division’s expected residual income for the current year with the proposed project is $1,804,000…

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