Divisional performance measures
Compare and contrast the use of residual income and return on investment in divisional performance measurement, stating the advantages and disadvantages of each.
Division Y of Chardonnay currently has capital employed of $100,000 and earns an annual profit after depreciation of $18,000. The divisional manager is considering an investment of $10,000 in an asset which will have a ten-year life with no residual value and will earn a constant annual profit after depreciation of $1,600. The cost of capital is 15%.
Calculate the following and comment on the results.
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(i)
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The return on divisional investment, before and after the new investment
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(ii)
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The divisional residual income before and after the new investment
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Explain the potential benefits of operating a transfer pricing system within a divisionalised company.