Question

Answer 1

Solution of the above problem is as under:

Information as given in the question:

	(Figure in Thousands of Dollars)
Division	Sales	Operating Income	Total Assets
Paint Stores	3850000	519750	1750000
Consumer	1200000	180000	1600000

Requirement 1: Calculation of Return on Investment (ROI) of each division

Return on Investment (ROI) =(Operating Income/Average Invested Assets)*100

Paint Stores: ROI= (519750/1750000)*100

= 29.70%

Consumer: ROI= (180000/1600000)*100

= 11.25%

Requirement 2: Calculation of Sales Margin of each division

Sales Margin: (Operating Income/Sales Revenue)*100

Paint Stores: Sales Margin=(519750//3850000)*100

= 13.5%

Consumer: Sales Margin=(180000/1200000)*100

=15%

Interpreting the result on the basis of Sales Margin

A high sales margin means that the company did well in managing its cost of sales. It also shows that the company has more to cover for operating, financing, and other costs. Thus, higher the sales margin, better it is.

Hence, in terms of managing cost of sales and generating gross profit, The CONSUMER Division did better than the Paint Stores Division.

The Consumer Division is more profitable on each dollar of sale.

Requirement 3: Calculation of Capital Turnover of each division:

Capital Turnover Ratio: Sales/Total Assets

Paint Stores: Capital Turnover Ratio: (3850000/1750000) times

=2.2 times

Consumer: Capital Turnover Ratio:(1200000/1600000) times

=0.75 times

Interpreting the result on the basis of Capital Turnover Ratio

Capital Turnover Ratio indicates the capability of the organisation to achieve maximum sales with minimum amount of capital employed. Hence, higher the capital turnover ratio better is the situation.

Thus, the Paint Stores Division is more efficient in generating sales with its assets

Requirement 4: Calculation of Expanded ROI of each division:

Expanded ROI: (Sales Margin X Investment Turnover Ratio)

Paint Stores: Expanded ROI= (13.5 X 2.2)%

=29.70%

Consumer: Expanded ROI= (15 X 0.75)%

=11.25%

Interpreting the result on the basis of Expanded ROI

Return on Investment indicates the amount of profit earned on every dollar invested

The consumer division's profitability on each doller of sales is MORE (15%) than the Paint Stores division's profitability. However, the paint store division's efficiency is MORE (2.2 times) than the Consumer division's efficiency. These results cause the paint store division's ROI to be MORE then the consumer division's ROI.

Requirement 5: Calculation of Residual Income (RI) of each division

Residual Income (RI)= Operating Income-(Total Assets X Return on Investment)

Paint Stores: RI= 519750-(1750000 X 29.70%)=0

Consumer: RI= 180000-(1600000 X 11.25%)=0

Residual Income represents any excess of a department's income over the opportunity cost of the capital that it employs. A positive residual income means that the department has met the minimum return requirement while a negative residual income means that the department has failed to meet it.