Question
Osim Industries produces tool and die machinery for manufacturers. The company expanded vertically in 2014 by acquiring one of its suppliers of alloy steel
Osim Industries produces tool and die machinery for manufacturers. The company expanded vertically in 2014 by acquiring one of its suppliers of alloy steel plates, Quad Steel Company. In order to manage the two separate businesses, the operations of Quad Steel are reported separately as an investment center. Osim monitors its divisions on the basis of return on average investment (ROI), with investment defined as average operating assets employed. Management bonuses are determined on ROI. All investments in operating assets are expected to earn a minimum return of 12% before income taxes. Quad's ROI has ranged from 11.8% to 14.7% since 2014. During the fiscal year ended November 30, 2021, Quad Steel contemplated a capital acquisition with an estimated ROI of 18%; however, division management decided against the investment because it believed the investment would decrease Quad's overall ROI. Quad Steel manager is considering an investment of RM11,000 in an asset which will have a ten-year life with no residual value and will earn a constant annual profit after depreciation of RM2,595. The cost of capital is 14%. The 2021 operating statement for Quad follows. The division's operating assets employed were RM15,750,000 at November 30, 2021, a 5% increase over the 2020 year-end balance. Quad Steel Division Operating Statement for the year ended November 30, 2021 RM'000 RM'000 Sales revenue 25,000 Less expenses: Cost of goods sold 16,500 Administrative expenses 3,955 Selling expenses 2,700 (23,155) Operating income before tax 1,845 Required: a) Calculate the return on divisional investment (ROI), before and after the new investment. Comment on your answer. (3 marks) b) Calculate the divisional residual income (RI) before and after the new investment. Comment on your answer. (4 marks) c) Give FOUR (4) reasons why is residual income a better measure for performance? (4 marks) d) What is the difference between residual income and EVA? (2 marks) e) What is the primary disadvantage of using return on investment? (2 marks)
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