Question

Jason Kemp was torn between conflicting emotions. On the one hand, things were going so well. He had just completed 6 months as the assistant financial manager in the Electronics Division of Med-Products Inc. The pay was good, he enjoyed his coworkers, and he felt that he was part of a team that was making a difference in American health care. On the other hand, his latest assignment was causing some sleepless nights. Mel Cravens, his boss, had asked him to “refine” the figures on the division's latest project—a portable imaging device code—named ZM. The original estimates called for investment of $15.6 million and projected annual income of $1.87 million. Med-Products required an ROI of at least 15% for new project approval. So far, ZM's rate of return was nowhere near that hurdle rate. Mel encouraged him to show increased sales and decreased expenses in order to get the projected income above $2.34 million. Jason asked for a meeting with Mel to voice his concerns.

• Jason:Mel, I've gone over the figures for the new project and can't find any way to get the income above $1.9 million. The salespeople have given me the most likely revenue figures, and production feels that the expense figures are solid.
• Mel:Jason, those figures are just projections. Sales doesn't really know what the revenue will be. In fact, when I talked with Sue Harris, our sales vice president, she said that sales could range from $1.5 million to $2.5 million. Use the higher figure. I'm sure this product will justify our confidence in it!
• Jason:I know the range of sales was that broad, but Sue felt the $2.5 million estimate was pretty unlikely. She thought that during the first 5 years or so that ZM sales would stay in the lower end of the range.
• Mel:Again, Sue doesn't know for sure. She's just estimating. Let's go with the higher estimate. We really need this product to expand our line and to give our division a chance to qualify for sales-based bonuses. If ZM sells at all, our revenue will go up, and we'll all share in the bonus pool!
• Jason:I don't know, Mel. I feel pretty bad signing off on ROI projections that I have so little confidence in.
• Mel:(frustrated) Look, Jason, just prepare the report. I'll back you up.

Required:I would like a paragraph for each of 2) and 3).

1. What is the ROI of project ZM based on the initial estimates? What would ROI be if the income rose to $2.34 million?
2. Is there any way that Mel could ethically justify raising the sales estimates and/or lowering expense estimates?
3. What do you think Jason should do? Explain.

Please answer number 2 differently from the answer key.

Answer 1

According to the initial estimates by Sue Harris, sales vice president, sales may range from $1.5 million to $2.5 million, she also felt that 2.5 million sales in the initial years at least is very unlikely and sales will remain at the lower end of the range ie 1.5 million per year for the next 5 years.

So ROI = Return(benefit)/investment(cost) *100

= $1.5 million/ 15.6 million *100

=0.096 *100

= 9.6%.

When the income rises to $2.34 million,

ROI will be 2.34 /15.6 *100

= 0.15 *100

= 15%

As the expenses are pretty solid so there is almost no chance lowering the expenses and justifying it, as far as sales is concerned the projected sales is a lot lower than the required rate so its very unlikely to justify the increased sales.

In both the cases Jason can not ethically justify Mel's approach towards ROI achievement.

I think Jason should follow Standards of ethical conduct for management accountants and discuss this matter to the senior's of Mel Cravens.