Question

In: Accounting

Megamart, a retailer of consumer goods, provides the following information on two of its departments (each...

Megamart, a retailer of consumer goods, provides the following information on two of its departments (each considered an investment center).

Investment Center

Sales

Income

Average
Invested Assets

Electronics

34,200,000

2,907,000

17,100,000

Sporting goods

16,768,000

2,096,000

13,100,000

1. Compute return on investment for each department. Using return on investment, which department is most efficient at using assets to generate returns for the company?
2. Assume a target income level of 12% of average invested assets. Compute residual income for each department. Which department generated the most residual income for the company?
3. Assume the Electronics department is presented with a new investment opportunity that will yield a 14% return on investment. Should the new investment opportunity be accepted?

Compute return on investment for each department. Using return on investment, which department is most efficient at using assets to generate returns for the company?

Return on Investment
	Choose Numerator:	/	Choose Denominator:	=	Return on Investment
		/		=	Return on Investment
Electronics		/		=
Sporting Goods		/		=
Which department is most efficient at using assets to generate returns for the company?

Assume a target income level of 12% of average invested assets. Compute residual income for each department. Which department generated the most residual income for the company?

Investment Center	Electronics	Sporting Goods
Net income
Target net income
Residual income
Which department is most efficient at using assets to generate returns for the company?

Assume the Electronics department is presented with a new investment opportunity that will yield a 14% return on investment. Should the new investment opportunity be accepted?


Should the new investment opportunity be accepted?

Solutions

Expert Solution

Hey,

Part 1 :

Return on investment is calculated by this formula :

= Net Profit/Investment * 100

Return on Investment
	Choose Numerator:	/	Choose Denominator:	=	Return on Investment
	Income	/	Investment	=	Return on Investment
Electronics	2907000	/	17100000	=	17
Sporting Goods	2096000	/	13100000	=	16
Which department is most efficient at using assets to generate returns for the company?					Electronics

Part 2 :

Target Net income = Average Investment * 12%

Investment Center	Electronics	Sporting Goods
Net income	2907000	2096000
Target net income	2052000	1572000
Residual income	855000	524000
Which department is most efficient at using assets to generate returns for the company?		Electronics

Part 3 :

Current Return on investment we are having on the electronics department is 17% and we are having an opportunity to earn a 14% return by making the new investment. Prima facie we can say we can't accept the investment opportunity as 14% is less than 17%. But if we imagine that we can't earn 17% by increasing our existing facility then having a 2nd best option is better. Imagine the normal bank deposit rate is 10 % then having 14 % is better than earning 10 %. So this decision is depending on the other factors, Prima Facie we shall not accept it.

Hope this made sense, and help you understand the concept.

ekkarill92 answered 1 year ago

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