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	$	5,700,000		$	9,700,000		$	8,800,000
Average operating assets	$	1,140,000		$	4,850,000		$	1,760,000
Net operating income	$	273,600		$	853,600		$	180,400
Minimum required rate of return		17.00	%		17.60	%		14.00	%

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 17% 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

1) Rate of return

	Margin	Turnover	ROI
Division A	4.8%	5	24%
Division B	8.8%	2	17.60%
Division C	2.05%	5	10.25%

2) Residual income

	Division A	Division B	Division
Net operating income	273600	853600	180400
Minimum operating income	-193800	-853600	-246400
Residual income	79800	0	-66000

Decision on the basis of ROI

Division A	Accept
Division B	Accept/Reject
Division C	Reject

Decision on the basis of Residual income

Division A	Accept
Division B	Accept/Reject
Division C	Reject