Question

The vice president of operations of Recycling Industries is evaluating the performance of two divisions organized as investment centers. Invested assets and condensed income statement data for the past year for each division are as follows:

	Business Division	Consumer Division
Sales	$42,800,000	$56,000,000
Cost of goods sold	23,500,000	30,500,000
Operating expenses	11,424,800	14,300,000
Invested assets	34,240,000	70,000,000

	Required:
1.	Prepare condensed divisional income statements for the year ended December 31, 20Y8, assuming that there were no service department charges.
2.	Using the DuPont formula for return on investment, determine the profit margin, investment turnover, and return on investment for each division. If required, round your answers to two decimal places.
3.	If management desires a minimum acceptable return on investment of 10%, determine the residual income for each division.
4.	Discuss the evaluation of the two divisions, using the performance measures previously determined in parts (1), (2), and (3).

Divisional Income Statements

1. Prepare condensed divisional income statements for the year ended December 31, 20Y8, assuming that there were no service department charges.

Recycling Industries

Divisional Income Statements

For the Year Ended December 31, 20Y8

1		Business Division	Consumer Division
2	Sales
3	Cost of goods sold
4	Gross profit
5	Operating expenses
6	Income from operations

Final Questions

2. Using the DuPont formula for return on investment, determine the profit margin, investment turnover, and return on investment for each division. If required, round your answers to two decimal places.

	Profit Margin	Investment Turnover	ROI
Business Division
Consumer Division

3. If management desires a minimum acceptable return of investment 10%, determine the residual income for each division.

	Residual Income
Business Division	$
Consumer Division	$

4. Discuss the evaluation of the two divisions, using the performance measures previously determined in parts (1), (2), and (3).

On the basis of income from operations, the Division is more profitable. However, income from operations does not consider the amount of invested assets in each division. On the basis of the rate of return on investment, the Division is more profitable. Even though the Division has a higher profit margin, the Division has a higher investment turnover, which generates the higher rate of return on investment. On the basis of residual income, the Division is the more profitable of the two divisions.

Please anwer questions by using Excel. Thanks!

Answer 1

Answer 1.

Answer 2.

Business Division:

Profit Margin = Income from Operations / Sales
Profit Margin = $7,875,200 / $42,800,000
Profit Margin = 18.40%

Investment Turnover = Sales / Invested Assets
Investment Turnover = $42,800,000 / $34,240,000
Investment Turnover = 1.25

ROI = Profit Margin * Investment Turnover
ROI = 18.40% * 1.25
ROI = 23.0%

Consumer Division:

Profit Margin = Income from Operations / Sales
Profit Margin = $11,200,000 / $56,000,000
Profit Margin = 20%

Investment Turnover = Sales / Invested Assets
Investment Turnover = $56,000,000 / $70,000,000
Investment Turnover = 0.80

ROI = Profit Margin * Investment Turnover
ROI = 20.0% * 0.80
ROI = 16.0%

Answer 3.

Business Division:

Residual Income = Income from Operations - Required Return * Invested Assets
Residual Income = $7,875,200 - 10% * $34,240,000
Residual Income = $4,451,200

Consumer Division:

Residual Income = Income from Operations - Required Return * Invested Assets
Residual Income = $11,200,000 - 10% * $70,000,000
Residual Income = $4,200,000

Answer 4.

On the basis of income from operations, the Consumer Division is more profitable. However, income from operations does not consider the amount of invested assets in each division. On the basis of the rate of return on investment, the Business Division is more profitable. Even though the Consumer Division has a higher profit margin, the Business Division has a higher investment turnover, which generates the higher rate of return on investment. On the basis of residual income, the Business Division is the more profitable of the two divisions.