Return on investment - After seeing the results of the segment analysis for the Nylon Fibers division, James Cameron wants all three divisions focusing on the correct avenues for improving division performance. Refer to Exhibit 10.4 and the related information on page 10-14 to answer the following questions.

Required

a. Calculate the margin and asset turnover for Centex Yarns three divisions. Show that margin asset turnover equals the return on investment for each division as reported in the text.

b. Compare the margin and asset turnover for the three divisions and make suggestions for increasing the return on investment of each division.

A E EXHIBIT 10.4 Segment margin income statement for Centex Yarns. B D Polyester Nylon Fibers Division Rope Division Fibers Division Total $ 10,600,000 $ 6,725,000 $8,650,000 $ 25,975,000 5,543,000 1,334,000 3,723,000 2,368,000 649,000 3,708,000 4,414,000 890,000 3,346,000 12,325,000 2,873,000 10,777,000 1 2 Revenue 3 Less variable expenses 4 Cost of goods sold 5 Selling & administrative 6 Contribution margin 7 Less traceable fixed expenses 8 Cost of goods sold 9 Selling & administrative 10 Segment margin 11 Common fixed expenses 12 Net operating income 1,685,000 236,000 1,802,000 $ 1,382,000 174,000 2,152,000 $ 2,208,000 273,000 865,000 $ 5,275,000 683,000 4,819,000 2,886,000 1,933,000 $ 10-14 CHAPTER 10 Decentralization and Performance Evaluation return on investment, to evaluate proposals to build new manufacturing facilities and to allo- cate corporate funds across various facilities. Return on investment is still widely used today to evaluate a broad range of investment options, from manufacturing plants to corporate training programs. It is also used to evaluate entire organizations, organizational units such as divi- sions, plants, and product lines, and individual investment projects. Finally, it can be used to evaluate past results or to predict future results. Formally defined, return on investment (ROI) measures the rate of return generated by an investment in assets. Expressed as a percentage, it is calculated as Operating income Segment margin ROI= Average operating assets Average operating assets or There is some variation in the income measure used in the calculation of ROI. When an entire organization is being evaluated, operating income, or income before interest and taxes, is a common choice, since at the corporate level, all expenses are under the CEO's control. When ROI is used to evaluate a unit within the organization, the income measure needs to be one that includes only those items that are under the unit manager's control. Some unit managers use the segment margin because it represents revenues and expenses that are directly trace- able to the operating unit and controllable by the unit manager. Whatever the income choice, the measure must be used consistently. Throughout the rest of the chapter, we are going to use "operating income" in future formulas, but be aware that segment margin" can always be substituted when the calculation is for a unit rather than the entire organization. Since the income measure used in the ROI calculation represents the results obtained for the entire year, the denominator needs to represent the assets used during the year. The most common measure chosen is a simple average of the assets used during the year, computed by adding the beginning and ending asset balances and dividing by 2: Beginning asset balance + Ending asset balance Average operating assets = 2 The assets to include in this calculation are those that were actually used in operations, among them cash; accounts receivable; inventory; and property, plant, and equipment. Any asset that was not used to support operations, such as a manufacturing facility that was shut down or a piece of equipment that was no longer in use, should not be included in the asset balance. Let's calculate the ROI for each of Centex Yarns' divisions. In the following calculations, the segment margins are drawn from Exhibit 10.4. Polyester Fibers Rope Nylon Division Division Fibers Division Segment Margin $1,802,000 $2,152,000 $ 865,000 Average Assets $8,153,000 $8,406,250 $2,703,000 ROI $1,802,000 = 22.1% $2,152,000 = 25.6% $ 865,000 $8,153,000 $8,406,250 = 32% $2,703,000 ROI is a relative measure of return. In other words, it says nothing about the dollar amount of return; it is simply a rate of return. Notice that of the three divisions, the Nylon Fibers divi- sion has the highest ROI, yet it also has the smallest segment margin and the smallest dollar amount of assets to use in generating that margin. Based solely on ROI, the Nylon Fibers divi- sion is outperforming the other two divisions. Based on segment margin alone, however, the Rope division is outperforming the other two divisions. THINK ABOUT IT 10.3 Return on investment is based on the book value of operating assets. However, book value may not be as realistic a measure of the assets' current value as fair market value or appraised value. What effect would using fair market value instead of book value have on the return on investment