Question

Required information

Use the following information for the Exercises below.

[The following information applies to the questions displayed below.]

Megamart, a retailer of consumer goods, provides the following information on two of its departments (each considered an investment center).

Investment Center	Sales			Income			Average Invested Assets
Electronics	$	34,800,000		$	3,306,000		$	17,400,000
Sporting goods		20,100,000			2,412,000			13,400,000

Exercise 9-10 Computing return on investment and residual income; investing decision LO A1

1. Compute return on investment for each department. Using return on investment, which department is most efficient at using assets to generate returns for the company?
2. Assume a target income level of 12% of average invested assets. Compute residual income for each department. Which department generated the most residual income for the company?
3. Assume the Electronics department is presented with a new investment opportunity that will yield a 15% return on investment. Should the new investment opportunity be accepted?

Compute return on investment for each department. Using return on investment, which department is most efficient at using assets to generate returns for the company?

	Return on Investment Choose Numerator: / Choose Denominator: = Return on Investment / = Return on Investment Electronics / = Sporting Goods / = Which department is most efficient at using assets to generate returns for the company?

Assume a target income level of 12% of average invested assets. Compute residual income for each department. Which department generated the most residual income for the company?

	Investment Center Electronics Sporting Goods Net income Target net income Residual income Which department is most efficient at using assets to generate returns for the company?

Assume the Electronics department is presented with a new investment opportunity that will yield a 15% return on investment. Should the new investment opportunity be accepted?

	Should the new investment opportunity be accepted?

Answer 1

Answer 1.

Electronics:

Return on Investment = Income / Average Invested Assets
Return on Investment = $3,306,000 / $17,400,000
Return on Investment = 19.00%

Sporting Goods:

Return on Investment = Income / Average Invested Assets
Return on Investment = $2,412,000 / $13,400,000
Return on Investment = 18.00%

Electronics department is more efficient than sporting goods department in terms of generating returns using assets.

Answer 2.

Electronics:

Residual Income = Income - Target Income Level * Average Invested Assets
Residual Income = $3,306,000 - 12% * $17,400,000
Residual Income = $1,218,000

Sporting Goods:

Residual Income = Income - Target Income Level * Average Invested Assets
Residual Income = $2,412,000 - 12% * $13,400,000
Residual Income = $804,000

Electronics department generated more residual income than sporting goods department.

Answer 3.

If return on investment of new investment opportunity is 15% which is lower than the return on investment of electronics department. So, electronics department should not accept this new investment opportunity.