Swan Systems developed and manufactures residential water filtration units that are inst...

Swan Systems developed and manufactures residential water filtration units that are installed under sinks. The filtration unit removes chlorine and other chemicals from drinking water. This Dutch company has successfully expanded sales of its units in the European market for the past 12 years. Swan started a U.S. manufacturing and marketing division six years ago and an Australian manufacturing and marketing division three years ago. Here are summary operating data for the last fiscal year:

Senior management is in the process of evaluating the relative performance of each division. The Netherlands division generates the most profits and has the largest investment of assets, as indicated by the following table:

After careful consideration, senior management decided to examine the relative performance of the three divisions using several alternative measures of performance: ROI (return on investment as measured by net assets, or total assets less liabilities), residual income (net income less the cost of capital times net assets), and both of these measures after allocated corporate overhead is subtracted from divisional income. The cost of capital in each division was estimated to be 8 percent. (Assume this 8 percent estimate is accurate.)

There was much debate about whether corporate overhead should be allocated to the divisions and subtracted from divisional income. It was decided to allocate back to each division that portion of corporate overhead that is incurred to support and manage the division. The allocated corporate overhead items include worldwide marketing, legal expenses, and accounting and administration. Sales revenue was chosen as the allocation base because it is simple and best represents the cause-and- effect relation between the divisions and the generation of corporate overhead.

Required:

a. Calculate ROI and residual income (1) before any corporate overhead allocations and (2) after corporate overhead allocations for each division.

b. Discuss the differences among the various performance measures.

c. Based on the data presented in the case, evaluate the relative performance of the three operating divisions. Which division do you think performed the best and which performed the worst?