Question

Pool Accessories, Inc., has two divisions—Furniture and Supplies. Assume for both divisions that the tax rate is 30 percent, and the cost of capital is 8%. The following segmented financial information is for the most recent fiscal year ended December 31.

	Furniture Division	Supplies Division
Sales	$3,000,000	$1,000,000
Cost of goods sold	1,600,000	430,000
Allocated overhead	375,000	125,000
Selling and administrative expenses	250,000	200,000
Average net operating assets	$8,500,000	2,100,000

a)Prepare a segmented income statement using the format presented in Figure 11.3 "Segmented Income Statements (Game Products, Inc.)". Include the profit margin ratio for each division at the bottom of the segmented income statement.

b)Using net income as the measure, which division is most profitable? Explain why this conclusion might be misleading.

c)Using profit margin as the measure, which division is most profitable?

d)Using ROI as the measure, which division is most profitable?

e)Using RI as the measure, which division is most profitable?

f)Using EVA as the measure, which division is most profitable? For the EVA calculation, the only adjustment to be made to net income is to deduct taxes. No adjustments are required for assets.

Answer 1

		Pool Accessories Inc.
		Divisional Income Statement
		Furniture Division	Supplies Division	Total
	Sales Revenue=(A)	$                  30,00,000.00	$                   10,00,000.00	$ 40,00,000.00
a)	Cost of goods sold=(B)	$                  16,00,000.00	$                      4,30,000.00	$ 20,30,000.00
	Gross Profit=(SALES-COGS)=(C )=(A)-(B)	$                  14,00,000.00	$                      5,70,000.00	$ 19,70,000.00
	Allocated Overhead=(D)	$                    3,75,000.00	$                      1,25,000.00	$    5,00,000.00
	Selling & Administerative Expenses=(E )	$                    2,50,000.00	$                      2,00,000.00	$    4,50,000.00
	Operating Income=(F )=(C )-(D )-(E )	$                    7,75,000.00	$                      2,45,000.00	$ 10,20,000.00
	Income Tax Expense =(G )=30%*(F )	$                    2,32,500.00	$                         73,500.00
	Net Income=(H)=(F)-(G)	$                    5,42,500.00	$                      1,71,500.00
	Profit Margin Ratio=Net Income/Sales Revenue=(H)/(A)	18.08%	17.15%
b)	On the basis of net income Furniture division is more profitable but it can be misleading due to the reason that it not considered assets needed to produce that income.
c )	As per profit margin measure Furniture division is more profitable.
	Its Profit Margin is 18.08% as compare to supplies division Profit Margin is 17.15%
d)	Return On Investment=Operating Income/Average Operating Assets
	Operating Income=(A)	$                    7,75,000.00	$                      2,45,000.00
	Average Operating Assets=(B)	$                  85,00,000.00	$                   21,00,000.00
	ROI=(A)/(B)	9.12%	11.67%
	As per ROI Method Supplies Division is more profitable.
e)	RI=Residual Method=Operating Income-(Average Operating Assets* Cost of Capital)
	Operating Income=(A)	$7,75,000.00	$                      2,45,000.00
	Average Operating Assets=(B)	$                  85,00,000.00	$                   21,00,000.00
	Cost of Capital=(C )	8%	8%
	RI=(A)-(B)* (C )	$                        95,000.00	$                         77,000.00
	On the basis of Residual IncomeFurniture Division is more profitable.
f)	EVA=Net operating Profit after taxes-(Average operating Assets after adjusted(Cost of Capital)
	Net Operating Profit after taxes	$5,42,500	$                      1,71,500.00
	Average Operating Assets*Cost of Capital=($8500000*8%)	$                    6,80,000.00
	Average Operating Assets*Cost of Capital=($2100000*8%)		$                      1,68,000.00
	EVA=	$                   -1,37,500.00	1,71,500.00
	As per EVA Method Supplies Division is more profitable.