Toris Fashion, Inc., sells clothing and accessories throughout North America. The companys compensation committee, made up of five members from the board of directors, is meeting to discuss the CEOs contract, which expires next month. The committee is currently reviewing financial information for the three most recent fiscal years: year 3 (most recent), year 2, and year 1 (shown as follows)

Tori's Fashion, Inc.

Income Statement

(dollar amounts are in thousands)

	Year 3	Year 2	Year 1
Sales	$96,525	$71,500	$55,000
Cost of good sold	28,958	21,450	16,500
Gross margin	$67,567	$50,050	$38,500
Selling and administrative expenses	60,200	43,800	33,000
Operating income	$7,367	$6,250	$5,500
Income tax expense (30% rate)	2,210	1,875	1,650
Net income	$5,157	$4,375	$3,850

Tori's Fashion, Inc.

Balance Sheet Average Balance

(dollar amounts are in thousands)

	Year 3	Year 2	Year 1
Assets	Average Balance	Average Balance	Average Balance
Cash	$11,776	$6,720	$5,200
Accounts receivable	10,752	8,320	4,600
Inventory	13,312	7,360	4,200
Total current assets	$35,840	$22,400	$14,000
Property, plant, and equipment (net)	38,400	24,000	15,000
Land (held for sale)	5,000	5,000	5,000
Total assets	$79,240	$51,400	$34,000
Liabilities and owners equity
Accounts payable	9,216	5,760	3,600
Other current liabilities	7,132	5,020	3,700
Total current liabilities	$16,348	$10,780	$7,300
Long-term liabilities	0	0	0
Total Liabilities	$16,348	$10,780	$7,300
Total owners equity	62,892	40,620	26,700
Total liabilities and owners equity	$79,240	$51,400	$34,000

The income statement indicates sales increased 30 percent from year 1 to year 2 and 35 percent from year 2 to year 3. Net income increased 14 percent from year 1 to year 2, and 18 percent from year 2 to year 3. One member on the committee, Vivian Bentley, would like to offer the CEO a multiyear extension with a significant bump in salary and thousands of shares of stock options. When questioned why, Vivian pointed to the positive results reflected on the income statement.

Another committee member, Carter Posey, agrees with Vivian that income statement trends look great, but she would like to review other measures of performance as well. Carter has asked you to come up with two measures of performance that go beyond simply looking at the income statement.

Required:

1. Calculate return on investment for each of the three years. Note that balance sheet amounts presented for each year are already average balances (i.e., no need to calculate average balances). Assume land held for sale is not an operating asset.
2. Calculate residual income for each of the three years assuming the companys cost of capital rate is 12 percent.
3. Summarize and explain your findings in parts 1 and 2 to the committee.