Morgan Industries manufactures die machinery. To meet its expansion needs, it recently acquired one of its suppliers, Vienna Steel in 2000. To maintain Viennas separate identity, Morgan reports Viennas operations as an investment strategic business unit (SBU). Morgan monitors all of its investment SBUs on the basis of return on investment (ROI). Management bonuses are based on ROI, and all investment SBUs are expected to earn a minimum return of 12 percent before income taxes.

Viennas ROI has ranged from 14 percent to 18 percent since 2000. The company recently has the opportunity for a new investment that would have yielded 13 percent ROI. However, division management decided against the investment because it believed that the investment would decrease the divisions overall ROI.

The 2002 operating statement for Vienna follows. The divisions operating assets were $13,000,000 at the end of 2002, and $12,264,150 in 2001.

VIENNA DIVISION Operating Statement For Year Ended December 31, 2002 Sales $25,000,000 Cost of goods sold 16,600,000 Gross profit 8,400,000 Operating expenses Administration $2,340,000 Selling 3,810,000 6,150,000 Income before income taxes $2,250,000

REQUIRED 1. Calculate the following performance measures for 2002 for Vienna division:

a. Return on Investment (ROI), where investment is defined as the average investment in operating assets employed. (6 marks)

b. Residual Income (RI) calculated on the basis of average operating assets employed. (4 marks) Page 10 of 14

2. (a) Which performance measure (ROI or RI) should Morgan Industries use to provide the proper incentive for each division to act autonomously in the firms best interests? Explain. (2 marks)

(b) Would Viennas management have been more likely to accept the capital investment opportunity if RI had been used as a performance measure instead of ROI? Explain. (2 marks)

3. Discuss the limitations of Morgan industries reward system (that is use of ROI) in awarding bonuses, using the concepts of intrinsic motivation and extrinsic motivation. (6 marks)