Selected sales and operating data for three divisions of different structural en

Question

Selected sales and operating data for three divisions of different structural engineering firms are
given as follows:

1. Compute the return on investment (ROI) for each division using the formula stated in terms of margin and turnover. (Round your Turnover answers to 2 decimal places. Round your Margin and ROI percentage answers to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

Margin Turnover ROI

Division A _______% _______ ____%

Division B _______% _______ ____%

Division C _______% _______ ____%

2. Compute the residual income (loss) for each division. (Loss amounts should be indicated by a minus sign. Round your Required Rate of Return percentage answers to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

Division A Division B Division C

Avg operating Assets ________ _________ _________

Required Rate of Return ________% ________% _________%

Required Operating Income _______ _________ _________

Actual Operating Income ________ __________ _________

Required Operating Income (above) _______ _______ ________

Residual Income (loss) ________ _________ _________

3. Assume that each division is presented with an investment opportunity that would yield a 20% rate of return.

  

a. If performance is being measured by ROI, which division or divisions will probably accept or reject the opportunity?

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 _______

Selected sales and operating data for three divisions of different structural engineering firms are
given as follows:

Explanation / Answer

Part 1)

The formula for calculating margin, asset turnover and ROI are given below:

Margin = Net Income/Net Sales*100

Asset Turnover Ratio = Net Sales/Average Operating Assets

ROI = Margin*Asset Turnover Ratio

____________

Using the values provided in the question, we get,

Division A:

Margin = 284,200/5,800,000*100 = 4.90%

Asset Turnover Ratio = 5,800,000/1,450,000 = 4

ROI = 4.90%*4 = 19.60%

____________

Division B:

Margin = 872,200/9,800,000*100 = 8.90%

Asset Turnover Ratio = 9,800,000/4,900,000 = 2

ROI = 8.90%*2 = 17.80%

____________

Division C:

Margin = 191,350/8,900,000*100 = 2.15%

Asset Turnover Ratio = 8,900,000/2,225,000 = 4

ROI = 2.15%*4 = 8.60%

_____________

Part 2)

_____________

Part 3)

a) Based on ROI, all the divisions would accept the investment opportunity expected to provide 20% returns. It is so, because the current ROI (19.60%, 17.80% and 8.60%) of all the divisions is less than 20% and accepting an investment with a return greater than the current ROI would result in an overall increase in the division's rate of return.

Tabular Representation:

____________

b) To determine the acceptance/rejection based on Residual Income, we will have to compare the minimum required rate of return and the return on the new investment opportunity. In the given case also, all the divisions would accept the investment opportunity, as the return provided by the new investment opportunity (20%) is greater than the minimum required rate (18%,17.80% and 15%) of all return in case of all the divisions. Acceptance of such an investment would result in an increase in the residual income for the divisions.

Tabular Representation:

Division A Division B Division C Avg Operating Assets 1,450,000 4,900,000 2,225,000 Required Rate of Return 18.00% 17.80% 15.00% Required Operating Income 261,000 872,200 333,750 Actual Operating Income 284,200 872,200 191,350 Required Operating Income (above) 261,000 872,200 333,750 Residual Income (Loss) $23,200 0 ($142,400)

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