Noonan Division has total assets (net of accumulated depreciation) of $3,000,000

Question

Noonan Division has total assets (net of accumulated depreciation) of $3,000,000 at the beginning of year 1. In addition, Noonan has been leasing a machine for $60,000 annually. Expected divisional income in year 1 is $495,000 including $42,000 annually in income generated by the leased machine after the lease payment of $60,000. Noonan's cost of capital is 12 percent. Noonan can cancel the lease on the machine without penalty at any time.

Noonan computes ROI using beginning-of-the-year net assets. What will the divisional ROI be for year 1 assuming Noonan does not cancel the lease on the machine?

What would divisional ROI be for year 1 assuming Noonan cancels the lease on the machine?

Noonan computes residual income using beginning-of-the-year net assets. What will the divisional residual income be for year 1 assuming Noonan does not cancel the lease on the machine?

What would divisional residual income be for year 1 assuming Noonan cancels the lease on the machine?

Noonan Division has total assets (net of accumulated depreciation) of $3,000,000 at the beginning of year 1. In addition, Noonan has been leasing a machine for $60,000 annually. Expected divisional income in year 1 is $495,000 including $42,000 annually in income generated by the leased machine after the lease payment of $60,000. Noonan's cost of capital is 12 percent. Noonan can cancel the lease on the machine without penalty at any time.

Explanation / Answer

(a)Noonan computes ROI using beginning-of-the-year net assets. What will the divisional ROI be for year 1 assuming Noonan does not cancel the lease on the machine?

Divisional ROI be for year 1 =  Expected divisional income in year 1/ beginning-of-the-year net assets

Divisional ROI be for year 1 = 495000/3000000

Divisional ROI be for year 1 = 16.5%

(b)What would divisional ROI be for year 1 assuming Noonan cancels the lease on the machine?

Divisional ROI be for year 1 = Expected divisional income in year 1 excludingincome generated by the leased machine / beginning-of-the-year net assets

Divisional ROI be for year 1 = (495000-42000)/3000000

Divisional ROI be for year 1 = 15.1%

(c)Noonan computes residual income using beginning-of-the-year net assets. What will the divisional residual income be for year 1 assuming Noonan does not cancel the lease on the machine?

Divisional residual income = Expected divisional income in year 1 - beginning-of-the-year net assets*required rate

Divisional residual income = 495000 - 3000000*12%

Divisional residual income = 135000

(d) What would divisional residual income be for year 1 assuming Noonan cancels the lease on the machine?

Divisional residual income = Expected divisional income in year 1 excludingincome generated by the leased machine - beginning-of-the-year net assets*required rate

Divisional residual income = (495000-42000) - 3000000*12%

Divisional residual income = 93000

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