Question

Goodwin Company has three segments: 1, 2, and 3. Data regarding these segments follow:

Segment 1          Segment 2          Segment 3

Contribution to indirect expenses            $ 432,000            $ 208,800            $ 72,000

Assets directly used by and identified

with the segment                                            3,600,000                 1,440,000         360,000

a. Calculate the return on investment for each segment. Rank them from highest to lowest.

b. Assume the cost of capital is 10% for a segment. Calculate the residual income for each segment. Rank them from highest to lowest.

c. Repeat (b), but assume the desired cost of capital is 14%. Rank the segments from highest to lowest.

d. Comment on the rankings achieved.

Answer 1

		Segment 1	Segment 2	Segment 3
		$	$	$
1	Contribution to indirect expenses	432,000	208,800	72,000
2	Assets directly used by and identified with the segment	3,600,000	1,440,000	360,000
3	Return on investment ( Contribution / Cost of assets assigned )	12.00%	14.50%	20.00%
4	Ranking based on return on investments	III	II	I
5	Cost of capital	10%	10%	10%
6	minimum return ( cost of assets x cost of capital ) - 2 x 5	360,000	144,000	36,000
7	Residual income ( excess of actual contribution over minimum return ) [1-6]	72,000	64,800	36,000
8	Ranking based on residual income	I	II	III
9	Cost of capital	14%	14%	14%
10	minimum return ( cost of assets x cost of capital ) - 2 x 9	504,000	201,600	50,400
11	Residual income ( excess of actual contribution over minimum return ) [1-10]	(72,000)	7,200	21,600
12	Ranking based on residual income	III	II	I