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:

Required:

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. Assume that each division is presented with an investment opportunity that would yield a 10% 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?

Division A Division B Division C Sales $ 12,080,000 $ 35,100,000 $ 25,100,000 Average operating assets $ 3,020,000 $ 7,020,000 $ 5,020,000 Net operating income $ 531,520 $ 526,500 $ 627,500 Minimum required rate of return 9.00 % 9.50 % 12.50 %

Explanation / Answer

Requirement 1 Return On Investment Division A : ROI        5,31,520 X 1,20,80,000 = 4.40%X 4 =17.60% 1,20,80,000      30,20,000 Division B : ROI        5,26,500 X 3,51,00,000 =1.50% X5 = 7.50% 3,51,00,000      70,20,000 Division C : ROI       6,27,500 X 2,51,00,000 =2.50% X5 = 12.50% 2,51,00,000      50,20,000 Requirement 2 Division A Division B Division C Average Operating Assets      30,20,000      70,20,000 50,20,000 Minimum required rate of return 9.00% 9.50% 12.50% Minimum required return        2,71,800        6,66,900     6,27,500 Actual Operating Income        5,31,520        5,26,500     6,27,500 Residual income        2,59,720       -1,40,400                  -   Residual income = Actual Operating income - Minimum Required Return Requirement 3 a Division A Division B Division C Return On Investment 17.60% 7.50% 12.50% Investment Opportunity Yield 10% 10% 10% Therefore, if the division is presented with an investment opportunity yielding 10%, it probably would Reject Accept Reject Requirement 3 b Division A Division B Division C Minimum required rate of return for computing residual income 9.00% 9.50% 12.50% Investment Opportunity Yield 10% 10% 10% Therefore, if the division is presented with an investment opportunity yielding 10%, it probably would Accept Accept Reject

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