Noonan Division has total assets (net of accumulated depreciation) of $2,500,000
ID: 2468450 • Letter: N
Question
Noonan Division has total assets (net of accumulated depreciation) of $2,500,000 at the beginning of year 1. One of the assets is a machine that has a net book value of $290,000. Expected divisional income in year 1 is $420,000 including $36,000 in income generated by the machine (after depreciation). Noonan’s cost of capital is 7 percent. Noonan is considering disposing of the asset today (the beginning of year 1).
Required: (a) 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.) Answer: 16.8
(b) 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.) Answer: 17.4
(c) 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.)
(d) 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)?
Explanation / Answer
(a)
Net income = $420,000
Total assets = $2,500,000
ROI = Net income / Total assets = $420,000/$2,500,000 = 16.8%
(b)
Net income = $420,000 - $36,000 = $384,000
Total assets = $2,500,000 - $290,000 = $2,210,000
ROI = $384,000/$2,210,000 = 17.40%
(c)
Residual income = Net income – (Total assets * Cost of capital)
Residual income = $420,000 – ($2,500,000*0.07) = $420,000 - $175,000 = $245,000
(d)
Residual income = $384,000 – ($2,210,000*0.07) = $384,000 - $154,700 = $229,300
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