Topic: - Holiday Entertainment - PERFORMANCE MEASUREMENT

Holiday Entertainment Corporation (HEC), a subsidiary of New Age Industries, manufactures go-carts and other recreational vehicles. Family recreational centers that feature not only go-cart tracks but miniature golf, batting cages, and arcade games as well have increased in popularity. As a result, HEC has been receiving some pressure from New Age's management to diversity into some of these other recreational areas. Recreational Leasing, Inc. (RLI), one of the largest firms that leases arcade games to family recreational centers, is looking for a friendly buyer. New Age's top management believes that RLI's assets could be acquired for an investment of $3.2 million and has strongly urged Bill Grieco, division manager of HEC, to consider acquiring RLI. Grieco has reviewed RLI's financial statements with his controller, Marie Donnelly, and they believe the acquisition may not be in the interest of HEC. "If we decide not to perform this, the New Age people are not going to be happy, " said Grieco. "If we could convince them to base our bonuses on something other than return on investment, maybe this acquisition would look more attractive. How would we do if the bonuses were based on residual income, using the company's 15 percent cost of capital." New Age Industries traditionally has evaluated all of its divisions on the basis of return on investment. The desired rate of return for each division is 20 percent. The management team of any division reporting an annual increase in the ROI is automatically eligible for a bonus. The management of divisions reporting a decline in the ROI must provide convincing explanations for the decline in order to be eligible for a bonus. Moreover, this bonus is limited to 50% of the bonus paid to divisions reporting an increase in ROI. In the following table are condensed financial statements for both HEC and RLI for the most recent year.

RLI HEC Sales revenue S 9,500,000 Leasing revenue $ 3,100,000 Variable expenses (1,300,000) (6,000,000) Fixed expenses (1,200,000) (1,500,000) Total operating income $ 600,000 $ 2,000,000 Current assets un 1,900,000 $ 2,300,000 Long-lived assets 1,100,000 5,700,000 Total assets 3,000,000 $ 8,000,000 Current liabilities Long-term liabilities 850,000 $ 1,400,000 Stockholders' equity 1,200,000 3,800,000 Total liabilities and stockholder's equity 950,000 2,800,000 $ 3,000,000 $ 8,000,000