Question

Franklin Technologies, Inc. has three divisions. Franklin has a desired rate of return of 12.0 percent. The operating assets and income for each division are as follows:

     

Divisions	Operating Assets				Operating Income
Printer	$	610,000			$	102,480
Copier		880,000				99,440
Fax		430,000				61,060
Total	$	1,920,000			$	262,980

Franklin headquarters has $127,000 of additional cash to invest in one of its divisions. The division managers have identified investment opportunities that are expected to yield the following ROIs:

	Expected ROIs for
Divisions	Additional Investments
Printer	13.5	%
Copier	12.5	%
Fax	11.5	%

Required

1. a-1. Calculate the ROI for each division.

2. a-2. Which division manager is currently producing the highest ROI?

3. b. Based on ROI, which division manager would be most eager to accept the $127,000 of investment funds?

4. c. Based on ROI, which division manager would be least likely to accept the $127,000 of investment funds?

5. d. Which division offers the best investment opportunity for Franklin?

6. g. Calculate the residual income:

1. (1) At the corporate (headquarters) level before the additional investment.

2. (2) At the division level before the additional investment.

3. (3) At the investment level.

4. (4) At the division level after the additional investment.

Answer 1

a-1) Printer division. ROI = 102480/610000 x 100 = 16.8%

Copier division, ROI = 99,440/880,000 x 100 = 11.3%

Fax division, ROI = 61060/430,000 x 100 = 14.2%

a-2) Printer division is currently producing 16.8% which is the highest ROI.

b) The Copier division will be most eager to accept the new investment offer as the new investment has ROI higher than its existing of 11.3%. By accepting the offer, the division will earn extra (12.5 - 11.3) = 1.2% than its existing ROI.

c) The Printer division will be least likely interested in the new investment offer as the new investment ROI is lower than its existing ROI of 16.8%.

d) The Printer division provides the company with the best investment opportunities as the ROI on new investment (i.e. 13.5%) is highest for Printer division.

g-1) At headquarter level before new investment, Desired capital return = 12% of 1920,000 = $ 230,400

Residual Income = Operating Income - Desired Capital return = $ 262,980 - $ 230,400 = $ 32,580

g-2) At division level,

Desired capital return,

Printer Division = 12% of 610,000 = $ 73,200

Copier Division = 12% of 880,000 = $ 105,600

Fax Division = 12% of 430,000 = $ 51,600

Residual Income,

Printer Division = $ 102,480 - $ 73,200 = $ 29,280

Copier Division = $ 99,440 - $ 105,600 = $ 6,160

Fax Division = $ 61,060 - $ 51,600 = $ 9460

g-3) At the Investment level, Desired Capital return = 12% of $ 127,000 = $ 15,240

  Residual Income,

  Printer Division = 13.5% of $ 127,000 - $ 15,240 = $ 1905

Copier Division = 12.5% of $ 127,000 - $ 15,240 = $ 635

Fax Division = 11.5% of $ 127,000 - $ 15,240 = $ - 635

g-4) after the new investment,

Residual Income,

  Printer Division = ($ 102,480 +13.5% of $ 127,000) - ($ 73,200 + $ 15,240) = $ 31,185

Copier Division = ($ 99,440 + 12.5% of $ 127,000) - ($ 105,600 + $ 15,240) = $ 6,795

Fax Division = ($ 61,060 + 11.5% of $ 127,000) - ($ 51,600 + $ 15,240) = $ 8,825