Question

Wescott Company has three divisions: A, B, and C. The company has a hurdle rate of 8 percent. Selected operating data for the three divisions are as follows:

	Division A		Division B		Division C
Sales revenue	$	1,290,000	$	1,053,000	$	1,052,000
Cost of goods sold		797,000		773,000		764,000
Miscellaneous operating expenses		71,000		59,000		60,000
Interest and taxes		55,000		48,000		48,000
Average invested assets		9,511,000		2,259,000		3,716,000

Wescott is considering an expansion project in the upcoming year that will cost $5.7 million and return $521,000 per year. The project would be implemented by only one of the three divisions.

1. Compute the ROI for each division.

2. Compute the residual income for each division.

3. Rank the divisions according to the ROI and residual income of each.

4-a. Compute the return on investment on the proposed expansion project.

4-b. Is this an acceptable project?

5. Without any additional calculations, state whether the proposed project would increase or decrease each division’s ROI.

6. Compute the new ROI and residual income for each division if the project was implemented within that division.

1. Compute the ROI for each division.

2. Compute the residual income for each division.

3. Rank the divisions according to the ROI and residual income of each.

4-a. Compute the return on investment on the proposed expansion project.

4-b. Is this an acceptable project?

5. Without any additional calculations, state whether the proposed project would increase or decrease each division’s ROI.

6. Compute the new ROI and residual income for each division if the project was implemented within that division.

Answer 1

1.

	Division A	Division B	Division C
Sales revenue	$ 1,290,000	$ 1,053,000	$ 1,052,000
Cost of goods sold	$     797,000	$     773,000	$     764,000
Miscellaneous operating expenses	$        71,000	$        59,000	$        60,000
Interest and taxes	$        55,000	$        48,000	$        48,000
Net Income	$     367,000	$     173,000	$     180,000
Average invested assets	$ 9,511,000	$ 2,259,000	$ 3,716,000
ROI = Net Income / Average invested assets	3.9%	7.7%	4.8%

2.

	Division A	Division B	Division C
Sales revenue	$ 1,290,000	$ 1,053,000	$ 1,052,000
Cost of goods sold	$     797,000	$     773,000	$     764,000
Miscellaneous operating expenses	$        71,000	$        59,000	$        60,000
Interest and taxes	$        55,000	$        48,000	$        48,000
Net Income	$     367,000	$     173,000	$     180,000
Average invested assets	$ 9,511,000	$ 2,259,000	$ 3,716,000
Charge on Capital @ 8%	$     760,880	$     180,720	$     297,280
Residual Income ( Net income - Charge on Capital)	$   (393,880)	$        (7,720)	$   (117,280)

3.

	Division A	Division B	Division C
Ranking based on ROI	3	1	2
Ranking based on Residual Income	3	1	2

4.a

	Proposed expansion project
Return	521,000.00
Investment	5,700,000.00
ROI	9.1%

4.b Yes, the proposal will be accepted, since the ROI is higher than the required rate of return

5. The proposal will increase the ROI of each division, since its ROI is higher than existing ROI of each division.

6. ROI of each division

	Division A	Division B	Division C
Existing Net income	$        367,000	$        173,000	$        180,000
Additional Income	$        521,000	$        521,000	$        521,000
Total Net income	$        888,000	$        694,000	$        701,000
Existing Assets	$    9,511,000	$    2,259,000	$    3,716,000
Additional Investment	$    5,700,000	$    5,700,000	$    5,700,000
Total Assets	$ 15,211,000	$    7,959,000	$    9,416,000
ROI	5.8%	8.7%	7.4%

Residual Income of each division

	Division A	Division B	Division C
Existing Net income	$        367,000	$        173,000	$        180,000
Additional Income	$        521,000	$        521,000	$        521,000
Total Net income	$        888,000	$        694,000	$        701,000
Existing Assets	$    9,511,000	$    2,259,000	$    3,716,000
Additional Investment	$    5,700,000	$    5,700,000	$    5,700,000
Total Assets	$ 15,211,000	$    7,959,000	$    9,416,000
Charge on Capital @ 8%	$    1,216,880	$        636,720	$        753,280
Residual Income	$     (328,880)	$          57,280	$        (52,280)

	Division A	Division B	Division C
Ranking based on ROI	3	1	2
Ranking based on Residual Income	3	1	2