Mining Company has two divisions. The following information is available: North
ID: 2586880 • Letter: M
Question
Mining Company has two divisions. The following information is available:
North Division South Division
North Division South Division
Revenue for year
$300,000
$500,000
Operating income before taxes for year
$100,000
$90,000
Average invested capital for year
$100,000
$200,000
Invested capital at end of year
$200,000
$300,000
Tax rate
30%
30%
After-tax cost of capital for year
20%
15%
1. Using operating income after taxes division: as the income measure, compute the following for each
A. Return on Investment (ROI).
B. Return on Sales (ROS)
C. Capital Turnover (CT)
D. Residual Income (RI)
In addition, briefly explain in words how you went about finding the values of ROI, ROS, CT & RI.
2. Which division is more successful? Why?
3. What did you use to calculate CT, average invested capital for year or invested capital at the end of the year and why?
Revenue for year
$300,000
$500,000
Operating income before taxes for year
$100,000
$90,000
Average invested capital for year
$100,000
$200,000
Invested capital at end of year
$200,000
$300,000
Tax rate
30%
30%
After-tax cost of capital for year
20%
15%
Explanation / Answer
1.
Workings:
2. The North Division is more successful as it has a higher ROI, ROS, Turnover, and RI.
3. The average invested capital for the year is used to calculate the CT. Since the revenue in the numerator is a flow variable and the capital invested would also be changing during the year, the average capital invested is considered for calculating the CT rather than the invested capital at the end of the year which is a stock variable.
A. Return on Investment (ROI) (ii / iii) 70.00% 31.50% B. Return on Sales (ROS) (ii / i) 23.33% 12.60% C. Capital Turnover (CT) (i / iii) 3.0 times 2.5 times D. Residual Income (RI) (iv) $50,000 $33,000