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	$	12,080,000		$	35,100,000		$	25,100,000
Average operating assets	$	3,020,000		$	7,020,000		$	5,020,000
Net operating income	$	531,520		$	526,500		$	627,500
Minimum required rate of return		9.00	%		9.50	%		12.50	%

Required:

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

2. Compute the residual income (loss) for each division.

3. Assume that each division is presented with an investment opportunity that would yield a 10% rate of return.

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

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

Answer 1

Requirement 1
Return On Investment
Division A : ROI	5,31,520	X	1,20,80,000	= 4.40%X 4	=17.60%
	1,20,80,000		30,20,000
Division B : ROI	5,26,500	X	3,51,00,000	=1.50% X5	= 7.50%
	3,51,00,000		70,20,000
Division C : ROI	6,27,500	X	2,51,00,000	=2.50% X5	= 12.50%
	2,51,00,000		50,20,000
Requirement 2
	Division A		Division B	Division C
Average Operating Assets	30,20,000		70,20,000	50,20,000
Minimum required rate of return	9.00%		9.50%	12.50%
Minimum required return	2,71,800		6,66,900	6,27,500
Actual Operating Income	5,31,520		5,26,500	6,27,500
Residual income	2,59,720		-1,40,400	-
Residual income = Actual Operating income - Minimum Required Return
Requirement 3 a
	Division A		Division B	Division C
Return On Investment	17.60%		7.50%	12.50%
Investment Opportunity Yield	10%		10%	10%
Therefore, if the division is presented with an investment opportunity yielding 10%, it probably would	Reject		Accept	Reject
Requirement 3 b
	Division A		Division B	Division C
Minimum required rate of return for computing residual income	9.00%		9.50%	12.50%
Investment Opportunity Yield	10%		10%	10%
Therefore, if the division is presented with an investment opportunity yielding 10%, it probably would	Accept		Accept	Reject