Question

Return on Investment and Residual Income
Johnson Company has two sources of funds: long-term debt and equity capital. Johnson Company has profit centers in the following locations with the following net incomes and total assets:

		Net Income	Assets
Las Vegas		$1,310,000	$4,000,000
Dallas		1,550,000	8,000,000
Tampa		2,390,000	12,000,000

a. Calculate ROI for each profit center and rank them from highest to lowest based on ROI.

Round ROI to the nearest whole percentage.

	ROI	Rank
Las Vegas	Answer	Answer
Dallas	Answer	Answer
Tampa	Answer	Answer

b. Calculate residual income for each profit center based on a desired ROI of 5% and rank them from highest to lowest based on residual income.

	ROI	Rank
Las Vegas	Answer	Answer
Dallas	Answer	Answer
Tampa	Answer	Answer

Answer 1

(a)

Return on investment ( Net income/ Assets)

	Net Income	Assets	Return on investment ( Net income/ Assets)
Las Vegas	$1,310,000	$4,000,000	1,310,000/4,000,000 = 33%
Dallas	1,550,000	8,000,000	1,550,000/8,000,000 = 19%
Tampa	2,390,000	12,000,000	2,390,000/12,000,000 = 20%

	Return on investment	Rank
Las Vegas	33%	1
Dallas	19%	3
Tampa	20%	2

(b)

Required rate of return = 5%

Residual income = Net Income - ( Assets x Required rate of return)

	Net Income	Assets	Residual income = Net Income - ( Assets x Required rate of return)
Las Vegas	$1,310,000	$4,000,000	1,310,000- (4,000,000 x 5%)= 1,110,000
Dallas	1,550,000	8,000,000	1,550,000- (8,000,000 x 5%)= 1,150,000
Tampa	2,390,000	12,000,000	2,390,000 - (12,000,000 x 5%)= 1,790,000

	Residual income	Rank
Las Vegas	1,110,000	3
Dallas	1,150,000	2
Tampa	1,790,000	1

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