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Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773

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Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773
Textbook Problem
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Return on Investment Ethical Considerations

Jason Kemp was torn between conflicting emotions. On the one hand, things were going so well. He had just completed 6 months as the assistant financial manager in the Electronics Division of Med-Products Inc. The pay was good, he enjoyed his coworkers, and he felt that he was part of a team that was making a difference in American health care. On the other hand, his latest assignment was causing some sleepless nights. Mel Cravens, his boss, had asked him to “refine” the figures on the division’s latest project—a portable imaging device code—named ZM. The original estimates called for investment of $15.6 million and projected annual income of $1.87 million. Med-Products required an ROI of at least 15% for new project approval. So far, ZM’s rate of return was nowhere near that hurdle rate. Mel encouraged him to show increased sales and decreased expenses in order to get the projected income above $2.34 million. Jason asked for a meeting with Mel to voice his concerns.

Jason: Mel, I’ve gone over the figures for the new project and can’t find any way to get the income above $1.9 million. The salespeople have given me the most likely revenue figures, and production feels that the expense figures are solid.

Mel: Jason, those figures are just projections. Sales doesn’t really know what the revenue will be. In fact, when I talked with Sue Harris, our sales vice president, she said that sales could range from $1.5 million to $2.5 million. Use the higher figure. I’m sure this product will justify our confidence in it!

Jason: I know the range of sales was that broad, but Sue felt the $2.5 million estimate was pretty unlikely. She thought that during the first 5 years or so that ZM sales would stay in the lower end of the range.

Mel: Again, Sue doesn’t know for sure. She’s just estimating. Let’s go with the higher estimate. We really need this product to expand our line and to give our division a chance to qualify for sales-based bonuses. If ZM sells at all, our revenue will go up, and we’ll all share in the bonus pool!

Jason: I don’t know, Mel. I feel pretty bad signing off on ROI projections that I have so little confidence in.

Mel: (frustrated) Look, Jason, just prepare the report. I’ll back you up.

Required:

  1. 1. What is the ROI of project ZM based on the initial estimates? What would ROI be if the income rose to $2.34 million?
  2. 2. CONCEPTUAL CONNECTION Do you agree that Jason has an ethical dilemma? Explain. Is there any way that Mel could ethically justify raising the sales estimates and/or lowering expense estimates?
  3. 3. What do you think Jason should do? Explain.

1.

To determine

Calculate the ROI of the project on initial estimates. Also, calculate the ROI if the income increases to $2.34 million.

Explanation

Return on Investment (ROI):

Return on investment can be defined as the amount of profit earned by the company on per dollar of investment. It can be computed by dividing operating income by the average operating assets.

Use the following formula to calculate the ROI of the project on initial estimates:

ROI=Operating IncomeAverage operating assets

Substitute $1,870,000 for operating income and $15,600,000 for average operating assets in the above formula.

ROI=$1,870,000$15,600,000=0

2.

To determine

Describe whether Person J has an ethical dilemma. Also, describe the ways through which Person M can justify the increase in sales or decrease in expense estimates.

3.

To determine

Describe the actions to be taken by Person J.

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