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ROI and Performance Issues

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Multi Divisional Organizations

A successful division manager has his division's ROI currently at 22%.
He is evaluating a plant expansion opportunity that is expected to produce an annual income of $500,000 and require an investment of $3,000,000. The corporation's cost of capital is 12%.

a. If his performance is based on ROI, will he be inclined to make the investment? Explain.
b. Calculate the residual income for the proposed investment.
c. If his performance is based on residual income, will she be inclined to make the investment? Explain.
d. Would corporate management encourage this division manager to make the investment? Explain.

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Solution Summary

The solution explains the impact on performance of using return on investment of residual income

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a. If his performance is based on ROI, will he be inclined to make the investment? Explain.

We first calculate the ROI of the new investment. ROI is calculated as net income/investment. The ROI for the new investment is 500,000/3,000,000=16.6%.
The existing ROI is 22%. If the expansion is undertaken, the overall ROI will reduce since the incremental ROI is lower.
The performance is ...

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