Question

Colonial Pharmaceuticals is a small firm specializing in new products. It is organized into two divisions, which are based on the products they produce. AC Division is smaller and the life of the products it produces tend to be shorter than those produced by the larger SO Division. Selected financial data for the past year is shown as follows. Divisional investment is as of the beginning of the year. Colonial Pharmaceuticals uses a 9 percent cost of capital and uses beginning-of-the-year investment when computing ROI and residual income. Ignore income taxes. AC Division SO Division Allocated corp. overhead $ 645 $ 1,350 Cost of goods sold 3,290 6,100 Divisional investment 9,900 75,500 R&D 2,450 3,150 Sales 9,800 15,500 SG&A 835 1,080 Required: a. Compute divisional income for the two divisions. b. Calculate the operating margin, which is equivalent to the return on sales, for the two divisions. c. Calculate ROI for the two divisions. d. Compute residual income for the two divisions.

Answer 1

Colonial Pharmaceuticals
a)
Calculation of divisional income for divisions
	AC Division	SO Division
Sales	9,800	15,500
Less: Cost of Goods Sold	3,290	6,100
Contribution	6,510	9,400
R&D	2,450	3,150
SG & A	835	1,080
Allocated Corporation Overhead	645	1,350
Divisional Operating Income	2580	3820
b)Calculation of Operating Margin
Operating Margin=(Division Net margin/Sales)*100
	AC Division	SO Division
Divisional Operating Income	2,580	3,820
Sales	9,800	15,500
Operating Margin	26.33%	24.65%
c)
Calculation Of ROI
	AC Division	SO Division
Divisional Operating Income	2,580	3,820
Divisional Investment	9,900	75,500
ROI=(Divisional Operating Income/Divisional Investment)*100
Hence, ROI	26.06%	5.06%
	(2580/9900)*100	(3820/75500)*100
d) Calculation of Residual Income
	AC Division	SO Division
Divisional Investment	9,900	75,500
Cost of Capital	9%	9%
Margin Required	891	6,795
Operating Margin earned	2,580	3,820
Residual Income /(loss)	1,689	(2,975)
Residual Income=Operating Margin Earned-Margin Required to be earned