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 $ 15,900,000 $3,180,000 $ 636,000 Division B Sales Average operating assets Net operating income Minimum required rate of return Division C $ 28,720,000 S 20,720,000 $ 7,180,000 $ 5,180,000 $430,800 621,600 7.00% 7.50% 12. 00% 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 8% rate of return a. If performance is being measured by ROl, 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? Complete this question by entering your answers in the tabs below Req 1 Req 2 Req 3A Req 3B Compute the return on investment (ROI) for each division using the formula stated in terms of margin and turnover. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Margin Turnover ROI Division A Division B Division C

Explanation / Answer

Part 1 ROI = Margin * Turnover ROI = Net operating Income X Sales Sales Average Operating Assets Division A = 636000 X 15900000 15900000 3180000 = 20% Division B = 430800 X 28720000 28720000 7180000 = 6% Division C = 621600 X 20720000 20720000 5180000 = 12% Part 2 Calculation of Residual Income Division A Division B Division C Average Operating Assets $    3,180,000 $     7,180,000 $ 5,180,000 Required Rate of Return 7% 7.5% 12% Minimum Required Return (1) $        222,600 $        538,500 $      621,600 Actual Net Operating Income (2) $        636,000 $        430,000 $      621,600 Residual Income (2-1) $        413,400 $      (108,500) $                  -   Part 3a Division A Division B Division C Return on Investment 20% 6% 12% An investment opportunity yield with 8% rate of return Reject Accept Reject Explanation If performance is being measured by ROI, both Division A and Division C probably would reject the 8% investment opportunity. These divisions' ROIs currently exceed 8%; accepting a new investment with a 8% rate of return would reduce their overall ROIs. Division B probably would accept the 8% investment opportunity, since accepting it would increase the division's overall rate of return. Part 3b Division A Division B Division C Minimum Required rate of Return 7% 7.5% 12% An investment opportunity yield with 8% rate of return Accept Accept Reject Explanation If performance is measured by residual income, both Division A and Division B probably would accept the 8% investment opportunity. The 8% rate of return promised by the new investment is greater than their required rates of return of 7% and 7.5%, respectively, and would therefore add to the total amount of their residual income. Division C would reject the opportunity, since the 8% return on the new investment is less than its 12% required rate of return.

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