## 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