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: Division A Division B Division C Sales $ 7,100,000 $ 11,100,000 $ 10,200,000 Average operating assets $ 1,420,000 $ 2,775,000 $ 2,040,000 Net operating income $ 440,200 $ 1,132,200 $ 351,900 Minimum required rate of return 25.00 % 40.80 % 22.00 % Required: 1. Compute the return on investment (ROI) for each division using the formula stated in terms of margin and turnover. (Round your answers to 2 decimal places.) 2. Compute the residual income (loss) for each division. (Loss amounts should be indicated by a minus sign. Round your "Required rate of return" to 2 decimal places.) 3. Assume that each division is presented with an investment opportunity that would yield a 27% 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?

Explanation / Answer

Req 1. Div A Div B Div C Sales 7,100,000 11,100,000 10,200,000 Average operating assets 1,420,000 2,775,000 2,040,000 Net income 440,200 1,132,000 351,900 ROI 31% 40.79% 17.25% (Net income/ Average Operating assets) Req 2: Div A Div B Div C Sales 7,100,000 11,100,000 10,200,000 Average operating assets 1,420,000 2,775,000 2,040,000 Net income 440,200 1,132,000 351,900 Min rate of return 25% 40.80% 22% Target income 355000 1132200 448800 Residual income 85,200 -200 -96,900 Req 3. When Investment opportunity is having 27% rate of return. Division C will accept the opportunity, as the actual ROI eanre by the division is less than this ROI. It will improve its ROI. Req 4: In case of residual income criterion, DIVISION A AND C shall accept the opportunity. Because the minimum rate of return is lower than actual ROI earned from investment. It will improve their residual income.

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