Noonan Division has total assets (net of accumulated depreciation) of $2,900,000

ID: 2453217 • Letter: N

Question

Noonan Division has total assets (net of accumulated depreciation) of $2,900,000 at the beginning of year 1. One of the assets is a machine that has a net book value of $200,000. Expected divisional income in year 1 is $370,000 including $34,000 in income generated by the machine (after depreciation). Noonan’s cost of capital is 9 percent. Noonan is considering disposing of the asset today (the beginning of year 1).

Noonan computes ROI using beginning-of-the-year net assets. What will the divisional ROI be for year 1 assuming Noonan retains the asset? (Round your answer to 1 decimal place.)

What would divisional ROI be for year 1 assuming Noonan disposes of the asset for its book value (there is no gain or loss on the sale)? (Round your answer to 1 decimal place.)

Noonan computes residual income using beginning-of-the-year net assets. What will the divisional residual income be for year 1 assuming Noonan retains the asset? (Round your answer to the nearest dollar amount.)

What would divisional residual income be for year 1 assuming Noonan disposes of the asset for its book value (there is no gain or loss on the sale)? (Round your answer to the nearest dollar amount.)

Explanation / Answer

ROI and RI is used to evaluate the performance of particulars divisions.

ROI = Some Measure of Income / Some Measures of Investment

The data given in the question is as under

Noonan Division

Particulars

Amount

Total Assets net accumulated depreciation

2900,000

Book Value of Particular Machine

200,000

Expected Divisional Income

370,000

Income Generated by Particular Machine

34,000

Cost of Capital

9 %

(‘a) Total Investment in Net Assets = 2900,000

Expected Income = 370,000

ROI = Divisional Income / Divisional Investemnt

ROI = 2900, 000/370,000

ROI = 12.8 %

(b)

Net Assets = 2900, 000- 200,000

Net Assets = 2700,000

Divisional Income = 370,000-34,000

Divisional Income = 336,000

ROI = 2700,000/336,000

ROI = 12.4 %

As machine is sold hence net book value of machine and income generated from machine will be excluded from divisional assets and income.

(‘C ) Residual Income ( RI) = Income – ( Investment x Hurdle Rate)

RI = 370,000 – (0.09 x 2900,000)

RI = 370,000- 261,000

RI = 109,000

(‘D)

RI = 336,000- (0.09 x 2700,000)

RI = 336,000-243,000

RI = 93,000