Wescott Company has three divisions: A, B, and C. The company has a hurdle rate
ID: 2583326 • Letter: W
Question
Wescott Company has three divisions: A, B, and C. The company has a hurdle rate of 8 percent. Selected operating data for the three divisions are as follows:
Wescott is considering an expansion project in the upcoming year that will cost $5.8 million and return $532,000 per year. The project would be implemented by only one of the three divisions.
Required:
1. Compute the ROI for each division. (Do not round your intermediate calculations. Round your percentage answer to 2 decimal places, (i.e. 0.1234 should be entered as 12.34%.))
2. Compute the residual income for each division. (Loss amounts should be indicated by a minus sign.)
3. Rank the divisions according to the ROI and residual income of each.
4-a. Compute the return on investment on the proposed expansion project. (Round your percentage answer to 2 decimal places, (i.e. 0.1234 should be entered as 12.34%.))
4-b. Is this an acceptable project?
5. Without any additional calculations, state whether the proposed project would increase or decrease each division’s ROI.
6. Compute the new ROI and residual income for each division if the project was implemented within that division. (Loss amounts should be entered with a minus sign. Enter your ROI percentage answers to 2 decimal places, (i.e., 0.1234 should be entered as 12.34%.))
Explanation / Answer
Answer (1)
Return on Investment (ROI)
=Net Profit / Average invested assets X 100
Division A
Division B
Division C
= $ 367,000 / 9,684,000 X 100
= 3.79 %
=$ 176,000 / 2,306,000 X 100
=7.63 %
=$184,000 / 3,793,000 X 100
= 4.85%
Working Notes:
Calculation of net profit
Particulars
Division A ($)
Division B ($)
Division C ($)
Sales revenue
1,295,000
1,072,000
1,074,000
Less: Cost of goods sold
800,000
787,000
780,000
Gross Profit
495,000
285,000
294,000
Less: Miscellaneous operating expenses
72,000
60,000
61,000
Operating profit
423,000
225,000
233,000
Less: Interest and taxes
56,000
49,000
49,000
Net Profit
367,000
176,000
184,000
Answer (2)
Residual Income
= Operating Profit – (Cost of capital or hurdle rate X Average invested assets)
Division A
Division B
Division C
= $ 423,000 - (8/100 X 9,684,000)
=$ 423,000 -774,720
= - $ 351,720 (Loss)
=$225,000 - (8/100 X 2,306,000)
=$225,000-$ 184,480
= $ 40,520 (Profit )
=$ 233,000 - (8/100 X 3,793,000)
=$ 233,000- $ 303,440
= - $ 70,440 (Loss)
Answer (3)
Ranking according to ROI
ROI
Rank
Division A
3.79 %
3rd
Division B
7.63 %
1st
Division C
4.85%
2nd
Ranking according to Residual income
Residual Income
Rank
Division A
- $ 351,720 (Loss)
3rd
Division B
$ 40,520 (Profit )
1st
Division C
- $ 70,440 (Loss)
2nd
Answer (4)
a- Return on investment on the proposed expansion project
=Net Profit / Average invested assets X 100
=$532,000/ $ 5,800,000 X 100
= 9.17 %
Note: For proposed expansion return (given in question) is taken as net profit and cost is taken as average invested assets.
b- Yes, this is acceptable because of high return on investment.
Division A
Division B
Division C
= $ 367,000 / 9,684,000 X 100
= 3.79 %
=$ 176,000 / 2,306,000 X 100
=7.63 %
=$184,000 / 3,793,000 X 100
= 4.85%
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