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	$	7,000,000		$	11,000,000		$	10,100,000
Average operating assets	$	1,750,000		$	5,500,000		$	2,525,000
Net operating income	$	427,000		$	1,111,000		$	338,350
Minimum required rate of return		20.00	%		20.20	%		17.00	%

Required:
1.	Compute the return on investment (ROI) for each division using the formula stated in terms of margin and turnover. (Round your Turnover answers to 2 decimal places. Round your Margin and ROI percentage answers to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

Division a Margin turnover roi

division b

division c

2.	Compute the residual income (loss) for each division. (Loss amounts should be indicated by a minus sign. Round your Required Rate of Return percentage answers to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

avg operating income

required rate of return

required operating income

actual operating income

required operating income above

required income loss)

3.	Assume that each division is presented with an investment opportunity that would yield a 22% rate of return.

  

a.	If performance is being measured by ROI, which division or divisions will probably accept or reject the opportunity?

            

Division a

division b

division c

  

b.	If performance is being measured by residual income, which division or divisions will probably accept or reject the opportunity?

            

Division a

division b

division c

Answer 1

1	Statement Showing ROI
	Particulars	Division A	Division B	Division C
	Sales($)	7,000,000	11,000,000	10,100,000
	Average Operating Assets($)	1,750,000	5,500,000	2,525,000
	Net Operating Income($)	427,000	1,111,000	338,350
	ROI	24.40%	20.20%	13.40%
	ROI = Net operating Income X Sales	427,000 X7,000,000	1,111,000 X11,000,000	338,350 X10,100,000
	Sales                      Avg. Operating Assets	7,000,000 X 1,750,000	11,000,000 X 5,500,000	10,100,000 X 2,525,000
2	Statement showing Residual Income
	Particulars	Division A	Division B	Division C
a	Average Operating Assets($)	1,750,000	5,500,000	2,525,000
b	Minimum Required Rate of Return(in %)	20%	20.20%	17%
c	Minimum Required Return (in $)	350,000	1,111,000	429,250
	(Average operating Assets*Min. Reqd. rate of return)
d	Actual Operating Income	427,000	1,111,000	338,350
e	Residual Income/(Loss)	77,000	-	(90900)
	(Actual Operating Income - Minimum Required Return)
3		Division A	Division B	Division C
	Return on Investment (ROI)	24.40%	20.20%	13.40%
	Decision based on Actual ROI	Reject	Accept	Accept
	Minimum Required Rate of Return for computing Residual Income	20%	20.20%	17%
	Decision based on ROI for computing Residual Income	Accept	Accept	Accept
	If there is an investment opportunity with 22% return then any division with a return higher than 22% would reject that investment opportunity
	However if the division is earning less then 22% then it would accept the investment opportunity.
	The above decision is based on this logic