Question

10-12 Return on investment (LO 3) Dale Decor sells home decor items through three distribution channels-retail stores, the Internet, and catalog sales. Each distribution channel is evaluated as an investment center. Selected results from the latest year are as follows: Retail Stores Internet Catalog Sales Sales revenue $10,000,000 $4,000,000 $3,200,000 Variable expenses 4,000,000 1,500,000 1,800,000 Direct fixed expenses 4,500,000 1,000,000 1,200,000 Average assets 8,000,000 4,000,000 2,000,000 Required rate of return 12% 12% 12% Required a. Calculate the margin, asset turnover, and ROI for each of the three distribution channels. b. The corporate office is giving the managers of each channel the option of a customer relationship management system that will allow the managers to gather data about their customers and be more effective in their marketing efforts. The system will cost $800.000 and is expected to generate $160,000 in additional annual segment margin. If distributior channel managers are evaluated based on the trend of their ROIs which managers will invest in the system? Explain your reasoning. C. Calculate the current residual income for each distribution channel. Calculate the residual income of each distribution channel assuming it purchases the new customer relationship management system. e.Why is the residual income for each distribution channel higher in part (b) than in part (a)?

Answer 1

	Retail Stores	Internet	Catalog Sales
Sales Revenue	10,000,000	4,000,000	3,200,000
Variable Expenses	4,000,000	1,500,000	1,800,000
Direct Fixed expenses	4,500,000	1,000,000	1,200,000
Net Operating Income	1,500,000	1,500,000	200,000
Average Assets	8,000,000	4,000,000	2,000,000
Required return	12%	12%	12%
Margin = Net operating Income/Sales	15.00%	37.50%	6.25%
Turnover = Sales/Average Operating Assets	1.25	1	1.6
ROI = Margin*Turnover	18.75%	37.50%	10.00%
b. After system
ROI	18.86%	34.58%	12.86%
Divisions Retail Stores and Catalog Sales will invest since ROI will increase
c.Residual Income = Operating Income - Average operating assets*required return	540,000	1,020,000	(40,000)
After purchase	604,000	1,084,000	24,000
e.Because % return from new system 160000/800,000 = 20% is higher than the required return of 12%

А Internet 4000000 1500000 1000000 =C2-C3-C4 4000000 0.12 Catalog Sales 3200000 1800000 1200000 =D2-D3-D4 2000000 0.12 B Retail Stores 2 Sales Revenue 10000000 3 Variable Expenses 4000000 4. Direct Fixed expenses 4500000 5 Net Operating Income =B2-B3-B4 6 Average Assets 8000000 7 Required return 0.12 8 9 Margin = Net operating Income/Sales =B5/B2 10 Turnover = Sales/Average Operating Assets =B2/B6 11 ROI = Margin *Turnover =B9*B10 12 13 b. After system 14 ROI =(B5+160000)/(B6+800000) 15 Divisions Retail Stores and Catalog Sales will =C5/C2 =C2/C6 =C9*C10 =D5/D2 =D2/D6 =D9*D10 =(C5+160000)/(C6+800000) =(D5+160000)/(D6+800000) 16 17 c. Residual Income = Opertaing Income - Aver=B5-B6*B7 =C5-C6*C7 =D5-D6*D7 18 After purchase =(B5+160000)-(B6+800000) *B7 =(C5+160000)-(C6+800000)*C7 =(D5+160000)-(D6+800000)*D7 19 e.Because % return from new system 160000