Question

(a) Sher Manufacturing Pty Ltd has two retail divisions., which have the following reported

results for the year:

Furnishing department                                                Dress making Division

Profit $5,400,000                                                                           $9,270,000

Average invested Capital 11,250,000                                          10,687,500

(i) Calculate the ROI for both divisions

(ii) Calculate residual income assuming the firm requires a return of 12% on invested capital (1

marks)

(iii) Which was the more successful division? Explain. (Hint: think carefully about this)

(b) Giratina is a retailer and is a division of a larger retail company. The following data relate to

the most recent year of operations:

Sales Revenue $8,400,000

Variable costs 70% of sales

Fixed costs 2,150,000

Average Invested Capital 1,850,000

(i) Calculate the division’s return on sales, investment turnover and return on investment. (2

marks)

(ii) Describe how the division improve its ROI. (hint issue the 2 component ratios to explain) (3

marks)

Answer 1

A)

1. Return on Investment = Operating profit / Average Invested capital

ROI for furnishing department = $ 5,400,000 / 11250,000

ROI for furnishing department = 0.48 i.e 48%

ROI for Dress making division = $ 9,270,000 / 10,687,500

ROI for Dress making division = 0.8674 i.e 86.74%

2.

Residual Income = Operating Profit - ( Invested capital * Required rate of return)

Residual Income for furnishing department = $ 5,400,000 - ( 11250000 * 12%)

Residual Income for furnishing department = $ 5,400,000 - 1,350,000

Residual Income for Furnishing department = $ 4,050,000

Residual Income for Dress making division = $ 9,270,000 - ( 10,687,500 * 12%)

Residual Income for Dress making division= $ 9,270,000 - 1,282,500

Residual Income for Dress making division = $ 7,987,500

3.

Dress making division is more successful division as the Return on investment as well as residual income is higher than the furnishing department. Here the residual income shows the income level beyond the expectation or excess of required rate of return, which is far more higher in dress making division, further it gives lmore return as compared to other division , so Dress making division is more successful division.

B)

Sales revenue = $ 8,400,000 variable cost = 70% of sales = 70% of $ 8400000 = $ 5,880,000 ,

Thus contribution margin = Sales - variable cost = $ 8,400,000 - $ 5,880,000 = $ 2,520,000

So Net Profit = Contribution margin - Fixed cost = $ 2520000 - 2,150,000 = $ 370,000

1.

a) Return on sale = Net profit / sales

Return on sales = $ 370,000 / 8400000 = 4.40%

b) Investment turnover = Net sales / Invested capital

Investment turnover = $ 8,400,000 / 1,850,000

Investment turnover = 4.54 i.e 4.54 :1

c) Return on Investment = operating Profit / Invested capital

Return on Investment = $ 370,000 / 1850000

Return on Investment = 0.20 i.e 20%

2.

In order to improve the Return on Investment the two components needs to be changed i.e The Operating profit and the Invested capital , here the net profit is at numerator when increased will increase the return on Investment so, to Improve ROI the Net profit needs to be increased. and further the Invested capital to be decreased so that the less denominator will fetch the higher ratio, but redcing the investment is not advisable in long run . so the best way to improve the return on investment is to increase the operating net profit by reducing the cost or increasing the proportionate production so as to utilise the fixed cost.