Jump Start Company (JSC), a subsidiary of Mason Industries, manufactures go-carts and other recreational vehicles. Family recreational centers that feature go-cart tracks along with miniature golf, batting cages, and arcade games have increased in popularity. As a result, JSC has been pressured by Mason management to diversify into some of these other recreational areas. Recreational Leasing, Inc. (RLI), one of the largest firms leasing arcade games to these family recreational centers, is looking for a friendly buyer. Mason’s top management believes that RLI’s assets could be acquired for an investment of $3.2 million and has strongly urged Bill Grieco, division manager of JSC, to consider acquiring RLI. Bill has reviewed RLI’s financial statements with his controller, Marie Donnelly, and they believe that the acquisition may not be in the best interest of JSC. “If we decide not to do this, the Mason people are not going to be happy,” said Bill. “If we could convince them to base our bonuses on something other than return on investment, maybe this acquisition would look more attractive. How would we do if the bonuses were based on residual income using the company’s 15 percent cost of capital?” Mason has traditionally evaluated all of its divisions on the basis of return on investment, which is defined as the ratio of operating income to total assets. The desired rate of return for each division is 20 percent. The management team of any division reporting an annual increase in the return on investment is automatically eligible for a bonus. The management of divisions reporting a decline in the return on investment must provide convincing explanations for the decline to be eligible for a bonus, and this bonus is limited to 50 percent of the bonus paid to divisions reporting an increase. The following condensed financial statements are for both JSC and RLI for the fiscal year ended May 31: Required: 1. If Mason Industries continues to use return on investment as the sole measure of division performance, explain why JSC would be reluctant to acquire RLI. Be sure to support your answer with appropriate calculations. 2. If Mason Industries could be persuaded to use residual income to measure the performance of JSC, explain why JSC would be more willing to acquire RLI. Be sure to support your answer with appropriate calculations. 3. Discuss how the behavior of division managers is likely to be affected by the use of: a. Return on investment as a performance measure b. Residual income as a performance measure (CMA adapted)

BuyFind

Cornerstones of Cost Management (C...

4th Edition
Don R. Hansen + 1 other
Publisher: Cengage Learning
ISBN: 9781305970663
BuyFind

Cornerstones of Cost Management (C...

4th Edition
Don R. Hansen + 1 other
Publisher: Cengage Learning
ISBN: 9781305970663

Solutions

Chapter
Section
Chapter 10, Problem 33P
Textbook Problem

Jump Start Company (JSC), a subsidiary of Mason Industries, manufactures go-carts and other recreational vehicles. Family recreational centers that feature go-cart tracks along with miniature golf, batting cages, and arcade games have increased in popularity. As a result, JSC has been pressured by Mason management to diversify into some of these other recreational areas. Recreational Leasing, Inc. (RLI), one of the largest firms leasing arcade games to these family recreational centers, is looking for a friendly buyer. Mason’s top management believes that RLI’s assets could be acquired for an investment of $3.2 million and has strongly urged Bill Grieco, division manager of JSC, to consider acquiring RLI.

Bill has reviewed RLI’s financial statements with his controller, Marie Donnelly, and they believe that the acquisition may not be in the best interest of JSC.

“If we decide not to do this, the Mason people are not going to be happy,” said Bill. “If we could convince them to base our bonuses on something other than return on investment, maybe this acquisition would look more attractive. How would we do if the bonuses were based on residual income using the company’s 15 percent cost of capital?”

Mason has traditionally evaluated all of its divisions on the basis of return on investment, which is defined as the ratio of operating income to total assets. The desired rate of return for each division is 20 percent. The management team of any division reporting an annual increase in the return on investment is automatically eligible for a bonus. The management of divisions reporting a decline in the return on investment must provide convincing explanations for the decline to be eligible for a bonus, and this bonus is limited to 50 percent of the bonus paid to divisions reporting an increase.

The following condensed financial statements are for both JSC and RLI for the fiscal year ended May 31:

Chapter 10, Problem 33P, Jump Start Company (JSC), a subsidiary of Mason Industries, manufactures go-carts and other

Required:

  1. 1. If Mason Industries continues to use return on investment as the sole measure of division performance, explain why JSC would be reluctant to acquire RLI. Be sure to support your answer with appropriate calculations.
  2. 2. If Mason Industries could be persuaded to use residual income to measure the performance of JSC, explain why JSC would be more willing to acquire RLI. Be sure to support your answer with appropriate calculations.
  3. 3. Discuss how the behavior of division managers is likely to be affected by the use of:
    1. a. Return on investment as a performance measure
    2. b. Residual income as a performance measure (CMA adapted)

Expert Solution

Want to see the full answer?

Check out a sample textbook solution.

Want to see this answer and more?

Experts are waiting 24/7 to provide step-by-step solutions in as fast as 30 minutes!*

*Response times vary by subject and question complexity. Median response time is 34 minutes and may be longer for new subjects.

Chapter 10 Solutions

Cornerstones of Cost Management (Cornerstones Series)
Ch. 10 - What is the transfer pricing problem?Ch. 10 - If the minimum transfer price of the selling...Ch. 10 - If an outside, perfectly competitive market exists...Ch. 10 - Identify three cost-based transfer prices. What...Ch. 10 - What is the purpose of Internal Revenue Code...Ch. 10 - Forchen, Inc., provided the following information...Ch. 10 - Refer to Cornerstone Exercise 10.1. Forchen, Inc.,...Ch. 10 - Ignacio, Inc., had after-tax operating income last...Ch. 10 - Carreker, Inc., has a number of divisions,...Ch. 10 - Refer to Cornerstone Exercise 10.4. Required: 1....Ch. 10 - Clanahan, Inc., has a number of divisions around...Ch. 10 - Jarriot, Inc., presented two years of data for its...Ch. 10 - Refer to Exercise 10.7 for data. At the end of...Ch. 10 - Refer to the data given in Exercise 10.8....Ch. 10 - Brewster Company manufactures elderberry wine....Ch. 10 - Xenold, Inc., manufactures and sells cooktops and...Ch. 10 - Mouton Perrier, Inc., has a number of divisions...Ch. 10 - Jocassee Furniture Manufacturing, Inc., has a...Ch. 10 - Sugarland, Inc., has a division in Indonesia that...Ch. 10 - Mossfort, Inc., has a division in Canada that...Ch. 10 - A multinational corporation has a number of...Ch. 10 - Consider the data for each of the following four...Ch. 10 - The following selected data pertain to the Argent...Ch. 10 - Fermat, Inc., has acquired two new companies, one...Ch. 10 - The key difference between residual income and EVA...Ch. 10 - If sales and average operating assets for Year 2...Ch. 10 - Anders Company provided the following information:...Ch. 10 - Refer to 10.22. If the imputed interest rate is...Ch. 10 - A company had WACC (weighted average cost of...Ch. 10 - Fillmore Industries is a vertically integrated...Ch. 10 - Raddington Industries produces tool and die...Ch. 10 - Lawanna Davis graduated from State U with a major...Ch. 10 - Ardmore, Inc., manufactures heating and air...Ch. 10 - Oriole, Inc., owns a number of food service...Ch. 10 - Corning Company has a decentralized organization...Ch. 10 - Greg Peterson has recently been appointed vice...Ch. 10 - Renslen, Inc., a truck manufacturing conglomerate,...Ch. 10 - Jump Start Company (JSC), a subsidiary of Mason...Ch. 10 - Carnover, Inc., manufactures a broad line of...Ch. 10 - Grate Care Company specializes in producing...

Additional Business Textbook Solutions

Find more solutions based on key concepts
If a business uses special journals, it generally will not need a general journal.

College Accounting, Chapters 1-27 (New in Accounting from Heintz and Parry)

When does a seller have the most leverage over a buyer?

Purchasing and Supply Chain Management

MATURITY RISK PREMIUM An investor in Treasury securities expects inflation to be 2.5% in Year 1,3.2% in Year 2,...

Fundamentals of Financial Management, Concise Edition (with Thomson ONE - Business School Edition, 1 term (6 months) Printed Access Card) (MindTap Course List)