Question

Selected sales and operating data for three divisions of different structural engineering firms are given as follows: Sales Average operating assets Net operating income Minimum required rate of return Division A $ 6,800,000 $ 1,360,000 $ 401,200 23.00% Division B $ 10, 800,000 $ 2,700,000 $ 1,069,200 39.60% $ 9,900,000 $ 1,980,000 $ 311,850 20.00% 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 25% 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?

Answer 1

Solution 1:

Computation of ROI
	Division A	Division B	Division C
Operating Income	$4,01,200	$10,69,200	$3,11,850
/Sales	$68,00,000	$1,08,00,000	$99,00,000
Margin	5.90%	9.90%	3.15%
Average Operating assets	$13,60,000	$27,00,000	$19,80,000
Turnover (Sales/ Average Operating Assets)	5.00	4.00	5.00
ROI (Margin* Turnover)	29.50%	39.60%	15.75%

Solution 2:

Computation of Residual Income
	Division A	Division B	Division C
Average Operating assets	$13,60,000	$27,00,000	$19,80,000
Operating Income	$4,01,200	$10,69,200	$3,11,850
Minimum Required return on average assets	$3,12,800	$10,69,200	$3,96,000
Residual Income	$88,400	$0	-$84,150

Solution 3:

a. Division A and Division B will accept the opportunity and Division C will reject the opportunity.

b. Division B will accept the opportunity and Division A + Division C will reject the opportunity.