Fancy Flower evaluates its department on the basis of ROI (return on investment), as a performance measure with investment defined as the average of the balance of the beginning and end of year asset. Management bonuses are also based on ROI. all investments in operating assets are expected to earn a minimum rate of return of 11%.

Tulip Department, one of Fancy Flower investment centers, has ROI which ranged from 14% to 17%. During the past year, Tulip has an investment opportunity that would yield an estimated rate of return of 13%. Tulips management decided against the investment because it believed the investment would decrease the department's overall ROI.

Last year's income statement for Tulip Department is given below. The department's operating assets employed were RM12,960,000 at the end of the year, which represents an 8% increase over the previous year-end balance.

1. Compute (i) Return on investment (ROI) and (ii) Residual Income (RI) as performance measures for Tulip Department. (2 marks)
2. Why do you think the management of Tulip had rejected the investment opportunity, when the decision is made based on ROI calculation? Explain. (2 marks)
3. Would the management of the Tulip Department have been more likely to accept the investment opportunity it had last year if residual income were used as a performance measure instead of ROI? Explain.
4. The Tulip Department is a separate investment center within the Fancy Flower. Identify the items Tulip must be free to control if it is to be evaluated fairly, other than using the ROI or residual income performance measures. (2 marks)
5. Provide two (2) examples of situations where the use of ROI can lead to decisions which can harm the future competitiveness of a company. (4 marks)

\begin{tabular}{|l|l|l|} \hline \multicolumn{3}{|c|}{ Tulip Department } \\ \multicolumn{1}{|c|}{ Income Statement for the year ended December 31} \\ \hline Sales & RM & RM \\ \hline Cost of goods sold & & 31,200,000 \\ \hline Gross Margin & & 16,500,000 \\ \hline Less operating expenses: & & 14,700,000 \\ \hline Selling expenses & & \\ \hline Administrative expenses & 5,620,000 & \\ \hline & 7,208,000 & 12,828,000 \\ \hline \end{tabular}