Question

Meiji Isetan Corp. of Japan has two regional divisions with headquarters in Osaka and Yokohama. Selected data on the two divisions follow:

	Division
	Osaka		Yokohama
Sales	$	10,200,000	$	32,000,000
Net operating income	$	816,000	$	3,200,000
Average operating assets	$	2,550,000	$	16,000,000

1. For each division, compute the return on investment (ROI) in terms of margin and turnover.

2. Assume that the company evaluates performance using residual income and that the minimum required rate of return for any division is 17%. Compute the residual income for each division.

3. Is Yokohama’s greater amount of residual income an indication that it is better managed?

Answer 1

Part 1 :

Return on Investment = Net Margin * Asset Turnover = (Net Operating Income / Sales) * (Sales / Average Operating Assets)

Osaka Division ROI = (816,000 / 10,200,000) * (10,200,000 * 2,550,000) = 8% * 4 = 32%

Yokohama Division ROI = (3,200,000 / 32,000,000) * (32,000,000 * 16,000,000) = 10% * 2 = 20%

Part 2 :

Residual Income = Net operating income - Minimum required return and minimum required return = (Average operating assets * Minimum required rate)

Residual Income (Osaka) = $816,000 - ($2,550,000 * 17%) = $816,000 - $433,500 = $382,500

Residual Income (Yokohama) = $3,200,000 - ($16,000,000 * 17%) = $3,200,000 - $2,720,000 = $480,000

Part 3 :

No, Yokohama's greater amount of residual income is not an indication that it is better managed. Yokohama division is just larger than Osaka division. Residual income is not a right measure to compare divisions with different sizes. If we carefully observe the Part 1, Osaka's ROI is more than Yokohama's ROI, which means Osaka is the division being managed well.