Question

Required information

Use the following information for the Exercises below.

[The following information applies to the questions displayed below.]

Megamart, a retailer of consumer goods, provides the following information on two of its departments (each considered an investment center).

Investment Center	Sales			Income			Average Invested Assets
Electronics	$	40,250,000		$	3,059,000		$	16,100,000
Sporting goods		21,780,000			2,178,000			12,100,000

Exercise 22-10 Computing return on investment and residual income; investing decision LO A1

1. Compute return on investment for each department. Using return on investment, which department is most efficient at using assets to generate returns for the company?
2. Assume a target income level of 10% of average invested assets. Compute residual income for each department. Which department generated the most residual income for the company?
3. Assume the Electronics department is presented with a new investment opportunity that will yield a 14% return on investment. Should the new investment opportunity be accepted?

Answer 1

Req 1.
Return on Investment:
			Electronics	Sporting
Income			3059000	2178000
Divide: Average Invested assets			16100000	12100000
Return on Investment			19%	18%
Req 2.
Residual Income:
			Electronics	Sporting
Income			3059000	2178000
Average Invested assets			16100000	12100000
Target income @10%			1610000	1210000
(Average assets *10%)
Residual income			1449000	968000
(Actual income-Target income)
Req 3.
When the decision is based on return on investmnet, the new opportunity shall be rejected as it will reduce the department ROI
However, it will increase the residual income of the department. Hence, the decision in favor of investment is taken.