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	$	12,360,000		$	28,360,000		$	25,450,000
Average operating assets	$	3,090,000		$	7,090,000		$	5,090,000
Net operating income	$	494,400		$	453,760		$	636,250
Minimum required rate of return		7.00	%		7.50	%		12.50	%

Required:

1. Compute the return on investment (ROI) for each division using the formula stated in terms of margin and turnover.

2. Compute the residual income (loss) for each division.

3. Assume that each division is presented with an investment opportunity that would yield a 8% rate of return.

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

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

Answer 1

1)		Division A	Division B	Division C
	Sales	12,360,000	28,360,000	25,450,000
	Average operating assets	3,090,000	7,090,000	5,090,000
	Net operating income	494,400	453,760	636,250
	Minimum required rate of return	7%	7.50%	12.50%
	ROI	16.00%	6.40%	12.50%
	ROI = Net Operating Income / Average Operating Asset
2)		Division A	Division B	Division C
	Sales	12,360,000	28,360,000	25,450,000
	Average operating assets	3,090,000	7,090,000	5,090,000
	Net operating income	494,400	453,760	636,250
	Minimum required rate of return	7%	7.50%	12.50%
	Minimum Return (Dollar)	216,300	531,750	636,250
	(Average Operating asset * Minimum required return in percentage)
	Residual Income	278,100	(77,990)	-
	Residual Income = Net Operating Income - Minimum desired return
3)-a	If performance is being measured by ROI	Accept	Reject	Accept
3-b)	If performance is being measured by residual income	Accept	Reject	Accept