Division A Division B Division C Sales $ 6,700,000 $ 10,700,000 $ 9,800,000 Aver
ID: 2347090 • Letter: D
Question
Division A Division B Division C
Sales $ 6,700,000 $ 10,700,000 $ 9,800,000
Average operating assets $ 1,340,000 $ 5,350,000 $ 1,960,000
Net operating income $ 388,600 $ 1,048,600 $ 298,900
Minimum required rate of return 22 % 19.6 % 19 %
Compute the return on investment (ROI) for each division, using the formula stated in terms of margin and turnover.
ROI
Division A ____%
Division B ____%
Division C ____%
2.
Compute the residual income for each division
Residual income ___$ ___$ ___$
3.
Assume that each division is presented with an investment opportunity that would yield a rate of return of 24%.
a.
If performance is being measured by ROI, which division or divisions will probably accept or reject the opportunity?
Accept or Reject
Division A _____
Division B _____
Division C _____
b.
If performance is being measured by residual income, which division or divisions will probably accept or reject the opportunity?
Division A _____
Division B _____
Division C _____
Explanation / Answer
Solution: 1. ROI Division A 29.00 % Division B 19.60 % Division C 15.25 % Working Notes: Return on investment (ROI) = Margin x Turnover Margin = Net Operating Income / sales Turnover = Sales / Average operating assets Return on investment (ROI) = Margin x Turnover Return on investment (ROI) = (Net Operating Income / sales) x (Sales / Average operating assets) Division A ' ROI = (Net Operating Income / sales) x (Sales / Average operating assets) Division A ' ROI = (388,600/6,700,000 ) x (6,700,000 /1,340,000) Division A ' ROI = 0.29 = 29.00 % Division B ' ROI = (Net Operating Income / sales) x (Sales / Average operating assets) Division B ' ROI = (1,048,600/10,700,000 ) x (10,700,000 /5,350,000) Division B ' ROI = 0.196= 19.60 % Division C ' ROI = (Net Operating Income / sales) x (Sales / Average operating assets) Division C ' ROI = (298,900/9,800,000 ) x (9,800,000 /1,960,000) Division C ' ROI = 0.1525 = 15.25% 2. Division A Division B Division C Residual income 93,800 0 -73,500 Working Notes: Division A Division B Division C Average operating assets (I) 1,340,000 5,350,000 1,960,000 Minimum required rate of return (II) 22% 19.60% 19% Minimum required return (III) = (I) x (II) 294,800 1,048,600 372,400 Actual net operating income (IV) 388,600 1,048,600 298,900 Residual income (V) = (IV) - (III) 93,800 0 -73,500 [ Actual net operating income - Minimum required return ] 3. a. Performance is being measured by ROI Accept or Reject Division A Reject Division B Accept Division C Accept b. Performance is being measured by residual income Accept or Reject Division A Accept Division B Accept Division C Accept Working Notes: Division A Division B Division C Return on investment (ROI) 29.00 19.60 15.25 offered Investment opportunity yielding 24%, hence, it will Reject Accept Accept [more than 24%] [Less than 24%] [Less than 24%] Minimum required return for computing residual income 22% 19.60% 19% Offered Investment opportunity yielding 24%, hence, it will Accept Accept Accept [Less than 24%] [Less than 24%] [Less than 24%] Please feel free to ask if anything about above solution in comment section of the question.