Keenan Music $--$ ROI vs$.$ RI Case

Keenan Music's CEO has been pondering about the recent proposal of the Specialty Guitar Project. The accountant has done a capital budgeting analysis on

the project and outlined the conditions that this project would be acceptable. However, the CEO is concerned about the impact of accepting this project on

the company's Return on Investment, which is a measure that is currently used in CEO's bonus contract. The CEO will receive extra bonus if the company's ROI

improves from prior year. So$,$ the accountant is asked to do a further analysis on this project.

The accountant has gathered the following information related to the Specialty Guitar Project and the company's financial information this year below:

Keenan Music financial data this year

Sales revenue

Operating net income

Operating assets

Minimum required return

Special Guitar Project

Annual Sales revenue

Contribution margin ratio

Annual fixed expenses

Required investment in assets

$1$ What is the annual operating net income for the Specialty Guitar?

Operating Net Income

$2$

Compute the margin, turnover, and Return on Investment $($ROI$)$ for Keenan Music this year, for the Specialty Guitar by itself, and for Keenan Music

next year assuming that the Specialty Guitar is added.

$3$ Compute the Residual Income $($RI$)$ for Keenan Music this year, for the Specialty Guitar by itself, and for Keenan Music next year assuming that the

$3$ Specialty Guitar is added.

Operating Net Income

Minimum Required Income

Residual Income

$($Please solve the remaning empty boxes.$)$

Feel Free to answer these questions too. Multiple choice.

$4$ After you completed all the above calculations, answer the following questions.

Important note: You will not receive credit for each individual question. You must answer ALL questions correctly to receive credit.

$4-1$ Under the current bonus contract, the CEO's bonus is based on improving ROI every year. Will he have incentives to accept the Specialty Guitar Project? Why or why not?

A$.$ YES, because ROI of the Specialty Guitar Project is positive.

B$.$ YES, because ROI after accepting the Specialty Guitar Project is lower than this year's ROI.

C$.$ NO$,$ because ROI after accepting the Specialty Guitar Project is lower than this year's ROI

D$.$ NO$,$ because ROI after accepting the Specialty Guitar Project is higher than this year's ROI

$4-2$ Change Keenan's Minimum Required Return from $15\%$ to $20\%,$ and observe what happens to the Residual Incomes.

A$.$ When the Minimum Required Return increases, RI decreases.

B$.$ When the Minimum Required Return increases, RI increases.

C$.$ When the Minimum Required Return increases, RI does not change.

D$.$ Can't be determined

$4-3$ Now, change Keenan's Minimum Required Return from $20\%$ to $12\%$ in the data section, and observe what happens to the Residual Incomes.

A$.$ When the Minimum Required Return decreases, RI decreases.

B$.$ When the Minimum Required Return decreases, RI increases.

C$.$ When the Minimum Required Return decreases, RI does not change.

D$.$ Can't be determined

$4-4$ Does changing Keenan's Minimum Required Return affect its ROIs?

A$.$ NO$.$

B$.$ YES.

C$.$ Can't be determined.

$4-5$ If the CEO's bonus contract used RI$,$ instead of ROI, will the CEO have incentives to accept the Specialty Guitar Project? Why or why not?

A$.$ NO$,$ because RI of the Specialty Guitar Project is positive.

B$.$ NO$,$ because RI after accepting the Specialty Guitar Project is higher than this year's RI$.$

C$.$ YES, because RI after accepting the Specialty Guitar Project is lower than this year's RI$.$

D$.$ YES, because RI after accepting the Specialty Guitar Project is higher than this year's RI$.$