Problem 12-4 Comparing Performance Using ROI (LO2 - CC4, 6) uses the return on i

Question

Problem 12-4 Comparing Performance Using ROI (LO2 - CC4, 6) uses the return on investment (ROI) measure to evaluate its managers. A summary of the performance of two divisions is given below: Average operating assets Net income Division A $ 180,000 32,400 Division B $ 240,000 40,800 The minimum required return on operating assets for Guenther Corporation is 16%. Required: 1-a. Compute the return on investment of Division A and Division B. DivisionA Division B Return on investment 1-b. According to Guenther's senior management, which division is the better performer? Division A Division B 2-a. Compute the residual income of Division A and Division B. DivisionA Division B Residual income

Explanation / Answer

Req 1a: Return on Investment: Division A Division B Average Operating Assets 180000 240000 Net Income 32400 40800 Return on Investment 18% 17% (Net Income/Average Operating assets) DIVISION-A is better performer. Req 2-a Residual Income Division A Division B Average Operating Assets 180000 240000 Net Income 32400 40800 Target Return (@ 16%) 28800 38400 Residual income 3600 2400 (Net Income -Residual income) DIVISION-A is better performer. Req 3 Return on investment after project: Average Operating Income (180000+80000) 260,000 Net Income (32400+14000) 46400 Return on Investment 17.84% (Net Income/Average Operating assets) No, shall be accepted as ROI has gone down. Residual Income: Average Operating Income (180000+80000) 260,000 Net Income (32400+14000) 46400 Target Income (@16%) 41600 Residual Income: 4800 (net income-target income) Yes, shall be accepted as residual income increases from $3600 to $4800

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