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	$	12,840,000		$	28,840,000		$	26,050,000
Average operating assets	$	3,210,000		$	7,210,000		$	5,210,000
Net operating income	$	564,960		$	346,080		$	755,450
Minimum required rate of return		6.00	%		6.50	%		14.50	%

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 7% 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

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 % %

Req 2

Compute the residual income (loss) for each division. (Do not round intermediate calculations. Loss amounts should be indicated by a minus sign.)

	Division A Division B Division C Residual income (loss)

Req 3A

Assume that each division is presented with an investment opportunity that would yield a 7% 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

Req 3B

Assume that each division is presented with an investment opportunity that would yield a 7% 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

1

	Margin	Turnover	ROI
Division A	4.40%	4.00	17.60%
Division B	1.20%	4.00	4.80%
Division C	2.90%	5.00	14.50%

Working for the answer:

1

Margin
Net operating income	564960	346080	755450
Divided By
Sales	12840000	28840000	26050000
Margin =Net operating income/Sales	4.40%	1.20%	2.90%

2

turn over
Sales	12840000	28840000	26050000
Divided By
Average operating assets	3210000	7210000	5210000
turn over =Sales/Average Operating Assets	4.00	4.00	5.00

3.

ROI
Margin	4.40%	1.20%	2.90%
Multiplied by
Turnover	4.00	4.00	5.00
ROI = Margin * Turnover	17.60%	4.80%	14.50%

_____________________________________________________________________________

2

Compute the residual income (loss) for each division.

	Division A	Division B	Division C
Residual income (loss)	372360	-122570	0

Working

net income(A)	564960	346080	755450
less:
Required Rate of Return*Net Operating Assets	6%*3210,000	6.50%*7210,000	14.50%*5210,000
Required income (B)	192600	468650	755450
Residual Income(loss)	372360	-122570	0

_________________________________________________________

3

Assume that each division is presented with an investment opportunity that would yield a 7% rate of return

Division A	reject
Division B	Accept
Division C	reject

__________________________________________

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

Division A	Accept
Division B	Accept
Division C	reject