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5.         The sales, operating income, and invested assets for each division of Salem Company are...

5.         The sales, operating income, and invested assets for each division of Salem Company are as follows:

            Operating

                Invested

             Sales

           Income

                Assets

Division C

$4,000,000

           $410,000

$3,500,000

Division D

3,500,000

             600,000

4,000,000

Division E

2,250,000

             780,000

7,000,000

Management has established a minimum rate of return for invested assets of 11%.

a

Determine the residual income for each division.

b

Based on residual income, which division is the most profitable?

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Answer #1

a)

Division C Division D Division E
Average Operating Assets 35,00,000 40,00,000 70,00,000
Net Operating Income 4,10,000 6,00,000 780000
  Minimum Required Rate of Return 11% 11% 11%
Residual Income  [ Net Operating Income-(Average Operating Assets * Minimum Required Rate of Return )] 25,000 1,60,000 10,000
Average Operating Assets * Minimum Required Rate of Return 3,85,000 4,40,000 7,70,000

Hence the correct answer is :

Residual Income : Division A= $ 25,000

Division B = $ 160,000

Division C= $ 10,000

b)Since Division B has the highest residual income, it is the most profitable

Hence the correct answer is Division B

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