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 $ 12,600,000 $ 35,750,000 $ 20,600,000 Average operating assets $ 3,150,000 $ 7,150,000 $ 5,150,000 Net operating income $ 516,600 $ 572,000 $ 597,400 Minimum required rate of return 9.00 % 9.50 % 11.60 % 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?

Answer 1

1)
		Margin	Turnover	ROI
	Division A	4.10%	4	16.40%
	Division B	1.60%	5	8.00%
	Division C	2.90%	4	11.60%
	Margin = Net operating income/sales
	Turnover = sales/Average operating assets
	ROI         = margin * turnover
2)				Division A	Division B	Division C
	Average operating assets			3,150,000	7,150,000	5,150,000
	Required rate of return			9%	9.5%	11.6%
	required operating income			283500	679250	597400
	Actual operating income			516,600	572,000	597,400
	Required operating income abo			283,500	679,250	597,400
	residual income (loss)			233,100	-107,250	0
	Residual income = net operating income -(average operating assets*min
	Required rate of return)
3a)	Division A	Reject
	Division B	Accept
	Division C	Reject
3b)	Division A	Accept
	Division B	Accept
	Division C	Reject