You have been asked by the company owners to evaluate the companys MCS with specific attention on whether the current compensation scheme is effective in encouraging good investment decisions by company managers. The owners define good investment decision as decisions have returns that are greater than the companys cost of capital. The companys corporate cost of capital is 10%

The current compensation policy evaluates managers of four of the companys responsibility (Centers, A, B, C and D) based on meeting or exceeding their current ROI. Tim, the company CFO, is proposing to change the compensation plan for these centers based on Residual Income (RI) rather than ROI. The RI compensation plan will give managers a bonus if their center has a positive RI. Under Tims proposed compensation scheme, RI will be computed assuming current assets are charged at 3% and fixed assets at 14%.

There are three other responsibility centers, Manufacturing (Center E), Human Resources (Center F) and Legal (Center G). These three centers are evaluated differently than Centers A, B, C and D. Center E manufactures the products sold by the company and the manager of that center is evaluated based on the efficiency in producing the product. There is a well-established relationship between inputs and outputs for Center E. Center F and G are evaluated based on meeting their budgeted expense target while accomplishing the tasks expected of their function.

There are no plans to change the ways the managers of Centers E, F and G are evaluated.

The following information has been prepared for four of the companys centers:

Center	Cash	Receivables	Inventories	Fixed Asset	Total Investment	Profit
A	$4	$12	$14	$50	$80	$12
B	$4	$16	$20	$80	$120	$18
C	$6	$20	$20	$94	$140	$21
D	$10	$25	$15	$100	$150	$21

1. What is the Return on Investment (ROI) for Center A?

2. What is the Residual Income (RI) for Center B assuming that the new compensation plan is implemented? Assume that current assets would be charged at 3% and fixed costs at 14%.

3. The general manager of Center C is evaluating an investment opportunity of $12 which is expected to generate $1.55 in profit for the center. The investment will increase the centers fixed assets by $9 and the current assets by $3. Given the current compensation scheme used by the company would the manager of Center C be likely to go ahead with this investment?

a. Yes, the manager would likely invest

b. No, the manager would be unlikely to invest

c. Not enough information to determine

4. The general manager of Center Ds is evaluating the same investment as described in the previous question. Assuming the newly proposed compensation scheme is implemented, and RI would be the used to evaluate performance, would the manager of center D be likely to go ahead with this investment? Assume RI would be computed by charging current assets at 3% and fixed costs at 14%.

a. Yes, the manager would likely invest

b. No, the manager would be unlikely to invest

c. Not enough information to determine

5. How would you classify Center A in terms of type of responsibility center according to the current (not proposed) plan?

a.Revenue

b. Engineering Expense

c. Discretionary Expense

d. Profit

e. Investment

f. Not enough information to determine

6. How would you classify Center D in terms of type of responsibility center according to proposed plan?

a.Revenue

b. Engineering Expense

c. Discretionary Expense

d. Profit

e. Investment

f. Not enough information to determine

7. How would you classify Center E in terms of type of responsibility center according to current plan?

a.Revenue

b. Engineering Expense

c. Discretionary Expense

d. Profit

e. Investment

f. Not enough information to determine

8. How would you classify Center F in terms of type of responsibility center according to current plan?

a.Revenue

b. Engineering Expense

c. Discretionary Expense

d. Profit

e. Investment

f. Not enough information to determine