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                                                              $12,000,000              $14,000,000              $25,000,000

Average operating assets                           $3,000,000                $7,000,000                $5,000,000

Net operating income                                  $600,000                   $560,000                   $800,000

Minimum required rate of return                14%                            10%                            16%

Required:

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

            ANSWER:     Division A margin             =          __________

                                    Division B margin             =          __________

                                    Division C margin             =          __________

                                    Division A turnover           =          __________

                                    Division B turnover           =          __________

                                    Division C turnover           =          __________

                                    Division A ROI                    =          __________

                                    Division B ROI                    =          __________

                                    Division C ROI                    =          __________

2.         Compute the residual income for each division.

            ANSWER:     Division A residual income                     =          __________

                                    Division B residual income                     =          __________

                                    Division C residual income                     =          __________

3.         Assume that each division is presented with an investment opportunity that would yield a 15% rate of return.

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

ANSWER:     Division A accept or reject?                   =          __________

                                    Division B accept or reject?                   =          __________

                                    Division C accept or reject?                   =          __________

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

            ANSWER:     Division A accept or reject?                   =          __________

                                    Division B accept or reject?                   =          __________

                                    Division C accept or reject?                   =          __________

Answer 1

1. computation of return on investment (ROI) for each division

ROI = Net operating income/sales * sales / Average opearating assets

Division A = $600,000/$12,000,000* $12,00,000/3,000,000 = 20%

Division B = $560,000/$14,000,000* $14,00,000/7,000,000 = 8%

Division C = $800,000/$25,000,000* $25,00,000/5,000,000 = 16%

2.         Compute the residual income for each division.

	Division A	Division B	Division C
Avg Operating assets	3,000,000	7,000,000	5,000,000
Required rate of return	14%	10%	16%
Minimum required return	420,000	700,000	800,000
Actual Operating income	600,000	560,000	800,000
Minimum reqiured return	420,000	700,000	800,000
Residual Income	180,000	-140,000	0

3.

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

	Division A	Division B	Division C
ROI	20.00%	8.00%	16.00%
accept/ reject	Reject	Accept	Reject

If perfoemance is measured by ROI Division A and C been reject in 15% opportunity. because it exceeds 15%, accepting a new investment with a 15% rate of return would reduce overall ROI. so division B can be accepted at 15% investment opportunity

b.         If performance is being measured by Residual income( RI), which division or divisions will probably accept the opportunity? Reject?

	Division A	Division B	Division C
ROI	14.00%	10.00%	16.00%
accept/ reject	Accept	Accept	Reject

Under Residual income, both Division A and B can be accepted with 15% investment opportunity, and by rejecting division C where it exceeds 15 % investment opportunity.