Raddington Industries is a manufacturer of tool and die machinery. Raddington is a vertically integrated company that is organized into two divisions. The Reigis Steel Division manufactures alloy steel plates. The Tool and Die Machinery Division uses the alloy steel plates to make machines. Raddington operates each of its divisions as an investment center. Raddington monitors its divisions on the basis of return on investment (ROI) with investment defined as average operating assets employed. Raddington uses ROI to determine management bonuses. All investments in operating assets are expected to earn a minimum return (cost of capital) of 11%. For many years, Reigiss ROI has ranged from 11.8% to 14.7%. During the fiscal year ended December 31, 2019, Reigis contemplated a capital acquisition with an

6 estimated ROI of 11.5%; division management, however, decided against the investment because it believed that the investment would decrease Reigiss overall ROI. Reigiss 2019 operating income statement follows. The divisions operating assets employed were $15,750,000 at December 31, 2019, a 5% increase over the 2018 year-end balance. Reigis Steel Division Operating Income Statement for the Year Ended December 31, 2019 Revenue $25,000,000 Cost of goods sold 16,500,000 Gross margin 8,500,000 Operating costs Administrative $3,955,000 Marketing 2,700,000 Operating costs 6,655,000 Operating income $ 1,845,000 Required Calculate the return on investment and residual income for 2019 for the Reigis Steel Division. Assume that the division had expensed all R&D expenses of $ 90,000, 120,000 and 150,000 in the last three years and an income tax rate of 40%. Assuming a uniform amortization period of 3 years, calculate the EVA if R&D expenses were to be capitalized. 1. Would the management of Reigis Steel Division have been more likely to accept the investment opportunity if residual income were used as a performance measure instead of ROI? Explain. 2. For each of the following questions, indicate whether the margin and turnover will increase, decrease, or remain unchanged as a result of the events described below (no need to compute), and then compute the new ROI figure (when possible). Consider each question separately, starting in each case from the original ROI computed in (1) above. a. By use of JIT to control the purchase of some items of raw materials, the company is able to reduce the average level of inventory by $1,000,000. b. Sales are increased by $1000,000; operating assets remain unchanged. c. Obsolete items of inventory carried on the records at a cost of $200,000 are scrapped and written off as a loss