Five years ago, Arlington Industries expanded vertically by acquiring one of its suppliers, Raddix Plastics. Arlington monitors its divisions based on both product contribution and return on investment (ROI), with “investment” defined as average operating assets employed. All investments in operating assets are expected to earn a minimum return of 11% before income taxes. Management bonuses are also determined based on ROI. The cost of goods sold at Raddix is fully variable while administrative expenses are not dependent on sales volume. Selling expenses are a mixed cost with 40% attributed to sales volume. Since Arlington acquired Raddix, the ROI at Raddix has ranged from 11.8% to 14.7%. During the fiscal year just ended, Raddix considered a capital acquisition with an estimated ROI of 11.5%; however, division management decided against the capital acquisition because it believed that the capital acquisition would decrease the division’s ROI. The abbreviated most recent income statement for Raddix is presented here. The division’s operating assets employed were $15,750,000 at year end, a 5% increase over the previous year-end balance.
Raddix Plastics Division Income Statement
For the Year Ended December 31 ($000 omitted)
Sales revenue $25,000
Expenses
Cost of goods sold $16,500
Administrative expenses 3,955
Selling expenses 2,700 23,155
Income from operations $ 1,845
*Source: Retired ICMA CMA Exam Questions.
Required:
A_Calculate the unit contribution margin for Raddix Plastics if 1,484,000 units were produced and sold during the fiscal year ended December 31.
B_Based on the average operating assets employed, calculate return on investment (ROI) and residual income (RI) for the Raddix Plastics division.
C_Explain why the management of Raddix Plastics would have been more likely to accept the proposed capital acquisition if RI rather than ROI was used as a performance measure.
D_Identify one disadvantage for the organization to focus only on ROI and RI, respectively.
E_Raddix Plastics is a separate investment center within Arlington Industries.Identify three other types of responsibility centers.
F_Identify the items that Raddix should control if it is to be evaluated fairly by using the ROI or RI performance measures.
