Question

Meiji Isetan Corp. of Japan has two regional divisions with headquarters in Osaka and Yokohama. Selected data on the two divisions follow:

	Division
	Osaka		Yokohama
Sales	$	9,100,000	$	21,000,000
Net operating income	$	455,000	$	1,470,000
Average operating assets	$	2,275,000	$	10,500,000

Required:

1. For each division, compute the return on investment (ROI) in terms of margin and turnover. (Do not round intermediate calculations. Enter your answers as a percent (i.e., 0.12 should be entered as 12).)

	Osaka Yokohama ROI % %

2. Assume that the company evaluates performance using residual income and that the minimum required rate of return for any division is 12%. Compute the residual income for each division.

	Osaka Yokohama Average operating assets Net operating income Minimum required return on average assets Residual income

3. Is Yokohama’s greater amount of residual income an indication that it is better managed?

Yes or No

Answer 1

1)
                      Osaka                            Yokohama
ROI                20%                                14%

Calculation -( net operating income / sales) × (sales/ Average operating assets)
Osaka= (455,000 / 9,100,000) × (9,100,000 / 2,275,000)
           = 0.05 × 4 =0.2 ×100 = 20%
Yokohama = (1,470,000 / 21,000,000) × (21,000,000 /10,500,000)
                  = 0.07 × 2 = 0.14 ×100 =14%

2)
                                              Osaka                         Yokohama
Average operating            $2,275,000              $10,500,000
assets
Net operating income       455,000                       1,470,000
Minimum required
return on average assets 273,000                    1,260,000
Residual income                    $182,000                 $210,000

Calculation - minimum required return on average assets = average operating assets × 12%
Osaka = 2,275,000 ×12% = 273,000
Yokohama = 10,500,000 × 12% =1,260,000

Residual income = Net operating income - minimumrequired return on average assets
Osaka = 455,000 - 273,000 =$182,000
Yokohama = 1,470,000 - $1,260,000 = $210,000

3)No, the Yokohama Division is simply larger than the Osaka Division and for this reason one would expect that it would have a greater amount of residual income. Residual income can’t be used to compare the performance of divisions of different sizes. Larger divisions will almost always look better. In fact, in the case above, the Yokohama Division does not appear to be as well managed as the Osaka Division. Notefrom Part (1) that Yokohama has only an 14% ROI as compared to 20% for Osaka