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	$	16,000,000		$	36,000,000		$	20,800,000
Average operating assets	$	3,200,000		$	7,200,000		$	5,200,000
Net operating income	$	752,000		$	576,000		$	540,800
Minimum required rate of return		9.00	%		9.50	%		10.40	%

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?

Req 1

Req 2

Req 3A

Req 3B

Compute the return on investment (ROI) for each division using the formula stated in terms of margin and turnover. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

	Margin Turnover ROI Division A % % Division B % % Division C % %

indicated by a minus sign.)

	Division A Division B Division C Residual income (loss)

Assume that each division is presented with an investment opportunity that would yield a 10% rate of return. If performance is being measured by ROI, which division or divisions will probably accept or reject the opportunity?

	Division A Division B Division C

	Assume that each division is presented with an investment opportunity that would yield a 10% rate of return. If performance is being measured by residual income, which division or divisions will probably accept or reject the opportunity? Division A Division B Division C

Answer 1

Answer 1 )

ROI = Margin * Turnover

Where Margin = Net operating income / Sales ; Turnover = Sales / Average operating assets

	Margin	Turnover	ROI
Division A	$752,000 /$16,000,000 = 4.70%	$16,000,000 /$3,200,000 = 5	23.5%
Division B	$576,000 / $36,000,000 = 1.6%	$36,000,000 /$7,200,000 = 5	8%
Division C	$540,800 / $20,800,000 =2.6 %	$20,800,000 /$5,200,000 = 4	10.40%

Answer 2)

Residual income = Net operating income - (Average operating assets * Minimum required rate of return)

	Division A	Division B	Division C
Residual income (loss)	[$752,000 -($3,200,000 * 9.00 %) ] = $464,000	[$576,000 -($7,200,000 * 9.50%) ] = ($108,000)	[$540,800 -($5,200,000 * 10.40%) ] = $0

Answer 3a

Division A	Reject
Division B	Accept
Division C	Reject

Explanation : If performance is being measured by ROI , Division A & C will reject  investment opportunity as their respective ROI is greater that the yield from  investment opportunity ie 10 %. Accordingly Division B will accept as its ROI is less the  the yield from  investment opportunity ie 10 %

Answer 3b

Division A	Accept
Division B	Accept
Division C	Reject

Explanation : If performance is being measured by Residual income , Division A & B will accept the investment opportunity as their respective required rate of return is less than the yield from  investment opportunity ie 10 %. Accordingly Division C will reject as its required rate of return is greater the  the yield from  investment opportunity ie 10 %