Determining Returns on Investment and Performance
Application Directions `
Determining Returns on Investment and Performance
Costs related to the expansion and enhancement of a company can be just as essential (and large) as costs related to normal business operations. It is important for companies to avoid stagnation and remain abreast of market trends and innovation. This can be achieved through marketing and research and development (R&D), which, as all other business functions, need funding and budgeting.
For this week’s Application, you will analyze costs related to marketing and R&D. You will review the following scenarios and information and use the concepts of return on investment, performance, and other ideas introduced in this week’s Resources to draw conclusions related to questions posed in the prompts.
1. Define a revenue center, a cost center, a profit center, and an investment center. Give an example of each type of center.
2. Harrison Handbags has an advertising budget of $150,000. The company believes that if it increases the advertising budget by $24,000, it will sell an additional 32,000 purses and each purse will provide an additional profit to the company of $1.00 before consideration of the advertising costs. What additional profit should the company expect if it accepts the proposed budget increase?
3. Brent Bybee is the manager of the packaging department of the Carnival Candy Company. He is responsible for all costs of his department except rent, property taxes, and salaries.
Budgeted costs for his department for the month of April were:
Labor $12,000
Materials 7,500
Supplies 1,700
Maintenance 3,500
Property taxes 1,000
Rent 1,800
Salaries 10,000
Utilities 5,000
Actual costs for the month of April were:
Labor $12,200
Materials 10,200
Supplies 1,650
Maintenance 3,500
Property taxes 1,100
Rent 1,800
Salaries 10,000
Utilities 5,000
Determine the variances for each cost for which Brent is responsible. Then, as the plant manager, write a memo to Brent analyzing your findings and discussing how you want to proceed.
4. The company of Holman’s and Sons has manufactured hockey sticks for more than 10 years. In 2007, Holman’s acquired Leavitt’s Lumber, which supplies materials for the hockey sticks. Holman’s designated its corporate headquarters as an investment center. In addition, Holman’s uses return on investment (ROI) to measure performance. Management bonuses are based in part on ROI. All investments are expected to earn a minimum rate of return of 15%.
Leavitt’s Lumber Company’s ROI has ranged from 17.2% to 19% since it was acquired. Leavitt’s had an investment opportunity in 2010 that had an estimated ROI of 16%. At the end of 2010, it was determined that Leavitt’s Lumber ROI for the year was 17%. Residual income for Leavitt’s Lumber in 2010 was $150,000.
As part of the management team at Leavitt’s Lumber, if you used ROI as the performance measure, would you have accepted the investment opportunity? If you had used residual income as the performance measure, would you have accepted the investment opportunity? Explain in detail your decision.