Green Company has prepared the following information for threeof its divisions:
ID: 2433972 • Letter: G
Question
Green Company has prepared the following information for threeof its divisions: Division Historical Cost ofInvestments Division Operating Income X $560,000 $66,500 Y 532,000 64,400 Z 350,000 43,120 a. Compute each division's return on investment andresidual income, assuming a 10% of capital. b. Suppose the net book value of each division'sinvestments is half of the historical cost. Using net bookvalue as the measure of investment, compute eachdivision's return on investment and residual income, assuminga 10% cost of capital. c. Comment on the division rankings in (a) and(b). d. If the division managers are rewarded on the basis ofreturn on investment or residual income, will they find itattractive to invest in new, more costly equipment. Green Company has prepared the following information for threeof its divisions: Division Historical Cost ofInvestments Division Operating Income X $560,000 $66,500 Y 532,000 64,400 Z 350,000 43,120 a. Compute each division's return on investment andresidual income, assuming a 10% of capital. b. Suppose the net book value of each division'sinvestments is half of the historical cost. Using net bookvalue as the measure of investment, compute eachdivision's return on investment and residual income, assuminga 10% cost of capital. c. Comment on the division rankings in (a) and(b). d. If the division managers are rewarded on the basis ofreturn on investment or residual income, will they find itattractive to invest in new, more costly equipment.Explanation / Answer
Division X Y Z Return on investment 66,500 / 560,000 = 11.875% 64,400 / 532,000 = 12.11% 43,120 / 350,000 = 12.32 % Division X Y Z Income 66,500 64,400 43,120 Less: Assumed Return 56,000 53,200 35,000 Residual Income 10,500 11,200 8,120 b) Division X Y Z Return oninvestment 66,500 /280,000 = 23.75% 64,400 / 266,000 =24.21% 43,120 / 175,000 =24.64 % Division X Y Z Income 66,500 64,400 43,120 Less: AssumedReturn 28,000 26,600 17,500 ResidualIncome 38,500 37,800 25,620 c) At a, division Y got the most residual income, following with Xand Z. In case b, division X got the most residual income, following withY and Z. In both cases, the rankings of return on investment is same, Z isthe best, following with Y and X. d) If the income cannot reach the previous level, they will try toavoid to invest in costly equipment. This is because, if invest incostly investment, cost of investment will increase. If the netincome do not increase much, it will pull down both return oninvestment and residual income, which also means reduce the awardof manager.
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