When the Smith & Bain Company formed three divisions a year ago, the president told the division managers that an annual bonus would be paid to the most profitable division. However, absolute division operating income as conventionally computed would not be used. Instead, the ranking would be affected by the relative investments in the three divisions. Options available include ROI and residual income. Investment can be measured using gross book value or net book value. Each manager has now written a memorandum claiming entitlement to the bonus. The following data are available:
All the assets are fixed assets that were purchased ten years ago and have ten years of useful life remaining. A zero terminal disposal price is predicted. Smith & Bainâs required rate of return on investment used for computing residual income is 10% of investment. Required: Which method for computing profitability did each manager choose? Make your description specific and brief. Show supporting computations. Where applicable, assume straight-line depreciation.
Gross Book Division Value of Operating Income Division Division Assets Mastex $480,000 $57,000 Banjo 456,000 55,200 Randal 300,000 36,960