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 $ 15,200,000 $ 35,200,000 $ 25,200,000 Average operating assets $ 3,040,000 $ 7,040,000 $ 5,040,000 Net operating income $ 668,800 $ 563,200 $ 655,200 Minimum required rate of return 9.00 % 9.50 % 13.00 %

Explanation / Answer

1) ROI=Net Operating Income/Average Operating Assets Divisions A B C Net Operating Income $                         668,800.00 $                        563,200.00 $                        655,200.00 Average Operating Assets $                      3,040,000.00 $                    7,040,000.00 $                    5,040,000.00 ROI= ($668800/$3040000)*100 ($563200/$7040000)*100 ($655200/$5040000)*100 ROI= 22% 8% 13% Residual Income=Actual Operating Income-Required Operating Income- Required Operating Income=Average Operating Assets* Required Rate of Return 2) Divisions A B C Required Rate of Return 9% 9.50% 13% Average Operating Assets $                      3,040,000.00 $                    7,040,000.00 $                    5,040,000.00 Required Operating Income ($3040000*9%) ($7040000*9.5%) (5040000*13%) Required Operating Income $                         273,600.00 $                        668,800.00 $                        655,200.00 Actual Operating Income $                         668,800.00 $                        563,200.00 $                        655,200.00 Residual Income $                         395,200.00 $                      (105,600.00) $                                         -   3(a) Divisions A B C ROI 22% 8.00% 13% If the division is presented with an investent opportunity Yielding 10% Reject Accept Reject 3(b) Minimum required rate of return 9% 9.50% 13% If the division is presented with an investent opportunity Yielding 10% Accept Accept Reject If Performance of these division is measured on the basis of ROI both Division A & C Reject it because its ROI exceeded 10%.A new investment with 10% Rate of return would reduce their overall rate of return. If Performance of these division is measured on the basis of Residual income both Division A & B accept it because its ROI is lower than 10%.A new investment with 10% rate of return would increase their overall rate of return.

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