Selected sales and operating data for three divisions of different structural en
ID: 2467223 • Letter: S
Question
Selected sales and operating data for three divisions of different structural engineering firms are given as follows:
Division A Division B Division C
Sales (A)$ 5,500,000 (B)$ 9,500,000 (C)$ 8,600,000
Average operating assets (A)$ 1,100,000 (B)$ 4,750,000 (C)$ 1,720,000
Net operating income (A)$ 253,000(B) $ 817,000 (C)$ 159,100
Minimum required rate of return (A)15.00 % (B)17.20 % (C)12.00 %
1.Compute the return on investment (ROI) for each division using the formula stated in terms of margin and turnover.
2.Compute the residual income (loss) for each division.
3. (two parts to this question)Assume that each division is presented with an investment opportunity that would yield a 17% rate of return.
A. If performance is being measured by ROI, which division or divisions will probably accept or reject the opportunity?
B.If performance is being measured by residual income, which division or divisions will probably accept or reject the opportunity?
B.If performance is being measured by residual income, which division or divisions will probably accept or reject the opportunity?
Explanation / Answer
The yeild with investment opportunity is 17% which is more than minimum required rate of return of Division A but lower than the current rate of return of 23% therefore the investment opportunity cannot be accepted.
The yeild with investment opportunity is 17% which is less than minimum required rate of return of Division B, therefore the investment opportunity cannot be accepted.
The yeild with investment opportunity is 17% which is more than minimum required rate of return and current rate of return of Division C therefore the investment opportunity can be accepted.
The division A will have positive residual income as minimum required rate of return is less than the yeild from investment opportunity therefore the investment opportunity can be accepted for division A
The division B will have negative residual income as minimum required rate of return is more than the yeild from investment opportunity therefore the investment opportunity cannot be accepted for division B.
The division C will have positive residual income as minimum required rate of return is less than the yeild from investment opportunity therefore the investment opportunity can be accepted for division C.
Sales $ 5,500,000 $ 9,500,000 $ 8,600,000 Operating Income $ 253,000 $ 817,000 $ 159,100 Average operating Assets $ 1,100,000 $ 4,750,000 $ 1,720,000 Minimum required rate of return 15.00% 17.20% 12.00% 1 Return on investment for each division using the formula stated in terms of margin and turnover is calculated by dividing operating income by average operating assets. Division A Division B Division C Operating Income $ 253,000 $ 817,000 $ 159,100 Average operating Assets $ 1,100,000 $ 4,750,000 $ 1,720,000 ROI 23.00% 17.20% 9.25% 2 The residual income for each division is calculated as under: The residual income for each division is the difference between operating income and the minimum return (minimum return is calculated by multiplying average operating assets with minimum required rate of return) Division A Division B Division C Operating Income(1) $ 253,000 $ 817,000 $ 159,100 Required return(Average operating assets×Minimum required rate of return) (2) $ 165,000 $ 817,000 $ 206,400 Residual Income(1-2) $ 88,000 $ - $ (47,300) 3 If each division is presented with an investment opportunity yielding 17% of rate of return then : Division A Division B Division C Rate of Return 23.00% 17.20% 9.25% Minimum required rate of return 15.00% 17.20% 12.00% Yeild with investment opportunity 17% 17% 17% Not Accepted Not Accepted AcceptRelated Questions
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