Question

Operating results for Triton Entertainment Limited for the year ended May 31, 2020 are as follows:

Sales $4,180,000

Operating income 623,700

Average operating assets 1,980,000

Minimum required rate of return 20%

Required: Consider the following questions independently. Carry out all calculations to two decimal places.

A. Compute Triton’s ROI and residual income.

B. Assume that the manager of Triton can increase sales by $350,000 and as a result operating income will increase by $60,000 without any increase in operating assets. What would the company’s ROI be now?

C. The owner of the company feels that an investment in operating assets of $500,000 will increase sales by $700,000 and operating income by $120,300. If you were the manager of Triton and are evaluated based on the company’s ROI would you want to make the change. Why or why not?

D. Using the information in part C would your answer change if you were evaluated on residual income. Why or why not?

Answer 1

A. Computation of ROI & Residual income is as follows:

ROI = ( Operating income / Average operating assets ) * 100

= ( $ 623,700 / $ 19,80,000 ) * 100

= 31.50%

Thus, ROI is 31.50%

Residual Income = Operating Income - ( Average operating Assets * Minimum required rate of return )

=$ 623,700 - ( $ 19,80,000 * 20% )

=$ 623,700 - $ 396,000

= $ 227,700

Thus, Residual Income is $ 227,700

B. Computation of ROI is as follows:

Operating income will increases by $ 60,000. Thus Operating income will be $ 683,700 ( $ 623,700 + $ 60,000 )

ROI = ( Operating income / Average operating assets ) * 100

= ( $ 683,700 / $ 19,80,000 ) * 100

= 34.53 %

Thus, after increasing sales, ROI will be $ 34.53%

C.

Investment in operating assets of $ 500,000. Thus Operating assets will be $ 24,80,000 ( $ 19,80,000 + $ 500,000 )

Operating income will increases by $ 120,300. Thus Operating income will be $ 744,000 ( $ 623,700 + $ 120,300 )

Manager of Triton make decision based on the company’s ROI

ROI = ( Operating income / Average operating assets ) * 100

=( $ 744,000 / $ 24,80,000 ) * 100

= 30.00%

If Triton company make an Investment that will lead to decrease in ROI by 4.53% ( 34.53% - 30.00% ) . ROI before making investment was 34.53% and after making investment is 30.00%

Thus, Management of Triton company should not make change as ROI is declining.

D.

Manager of Triton make decision based on the company’s Residual Income.

Residual Income = Operating Income - ( Average operating Assets * Minimum required rate of return )

=$ 744,000 - ( $ 24,80,000 * 20% )

=$ 744,000 - $ 496,000

= $ 248,000

If Triton company make an Investment that will lead to Increase in Residual Income. Residual Income before making investment was $ 227,700 and after making investment is $ 248,000. Increase in residual income after investment is $ 20,300 ( $ 248,000 - $ 227,700 )

Thus, Management of Triton company should make change as Residual income will Increase by $ 20,300

Note:

Higher ROI & Residual Income will always better.