Question

Adams Corporation operates three investment centers. The following financial statements apply to the investment center named Bowman Division.

BOWMAN DIVISION
Income Statement
For the Year Ended December 31, 2018
Sales revenue	$	106,280
Cost of goods sold		58,575
Gross margin		47,705
Operating expenses
Selling expenses		(2,650	)
Depreciation expense		(4,145	)
Operating income		40,910
Nonoperating item
Loss of sale of land		(4,500	)
Net income	$	36,410

BOWMAN DIVISION
Balance Sheet
As of December 31, 2018
Assets
Cash	$	12,512
Accounts receivable		40,406
Merchandise inventory		37,300
Equipment less accumulated depreciation		90,328
Nonoperating assets		10,300
Total assets	$	190,846
Liabilities
Accounts payable	$	9,507
Notes payable		63,000
Stockholders’ equity
Common stock		76,000
Retained earnings		42,339
Total liabilities and stockholder's equity	$	190,846

Required

3. Calculate the ROI for Bowman.

4. Adams has a desired ROI of 13 percent. Headquarters has $94,000 of funds to assign to its investment centers. The manager of the Bowman Division has an opportunity to invest the funds at an ROI of 15 percent. The other two divisions have investment opportunities that yield only 14 percent. Calculate the new ROI for Bowman division, if the investment opportunity is adopted by Bowman.

5. Based on the original data, calculate the original residual income. Also, calculate the new residual income based on information provided in Requirement d.

Answer 1

a.

ROI= Net Operating Income / Net Operating Investment = 40,910/(190,846-10,300) = 22.66%

Net operating investment = 190,846-10,300 = 180,546

b.

If new investment opportunity is adopted by Bowman, Bowman would invest at 15%

Return from investing in funds = 94000*15% = 14,100

Revised operating investment = 190,846-10,300 + 94000 = 274,546

New ROI = (40910+14,100)/274546 = 20.04%

c.

The minimum required return would be 13%

Residual Income = Net Operating Income - (Average Operating Asset X Minimum Required return)

                                = 40,910 – (180,546 *13%)

                                = $ 17,439

Revised Residual Income taking cue from 2^nd requirement = Revised Net Operating Income - (Revised Average Operating Asset X Minimum Required return)

= (40910+14,100) – (274,546*13%)

= $11083