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Thursday, 2 August 2012

Selected sales and operating data for three divisions of three different companies are given below:

Selected sales and operating data for three divisions of three different companies are given below:

  Division A Division B Division C  
  Sales $ 6,000,000   $ 10,000,000   $ 8,000,000  
  Average operating assets $ 1,500,000   $ 5,000,000   $ 2,000,000  
  Net operating income $ 300,000   $ 900,000   $ 180,000  
  Minimum required rate of return   15 %   18 %   12 %  


Required:
1.
Compute the return on investment (ROI) for each division, using the formula stated in terms of margin and turnover. (Do not round intermediate calculations. Omit the "%" sign in your response.)

  ROI
  Division A  %  
  Division B  %  
  Division C  %  


2.
Compute the residual income for each division. (Negative amounts should be indicated by a minus sign. Leave no cells blank - be certain to enter "0" wherever required. Omit the "$" sign in your response.)

      Division A    Division B    Division C
  Residual income $   $   $  


3.
Assume that each division is presented with an investment opportunity that would yield a rate of return of 17%.

a.
If performance is being measured by ROI, which division or divisions will probably accept or reject the opportunity?

   
  Division A Reject  
  Division B Reject  
  Division C Accept  


b.
If performance is being measured by residual income, which division or divisions will probably accept or reject the opportunity?

   
  Division A Accept  
  Division B Reject  
  Division C Accept  



Explanation: 1. 
Computation of ROI.

Division A:  ROI =
$300,000
×
$6,000,000
= 5% × 4 = 20%
$6,000,000 $1,500,000

Division B:  ROI =
$900,000
×
$10,000,000
= 9% × 2 = 18%
$10,000,000 $5,000,000

Division C:  ROI =
$180,000
×
$8,000,000
= 2.25% × 4 = 9%
$8,000,000 $2,000,000

2.
    Division A   Division B   Division C
  Average operating assets $ 1,500,000 $ 5,000,000 $ 2,000,000
  Required rate of return ×15 % ×18 % ×12 %
 








  Minimum required return $ 225,000   $ 900,000   $ 240,000  
 

















  Actual net operating income $ 300,000   $ 900,000   $ 180,000  
  Minimum required return (above)   225,000     900,000     240,000  
 








  Residual income $ 75,000   $ 0   $ (60,000)  
 



















3. a. & b.
  Division A Division B Division C
  Return on investment (ROI) 20% 18%   9%  
  Therefore, if the division is presented with an   investment opportunity yielding 17%, it probably would Reject   Reject   Accept  
  Minimum required return for computing residual income 15% 18%    12% 
  Therefore, if the division is presented with an   investment opportunity yielding 17%, it probably would Accept   Reject   Accept