Question

14-40. Comparing Business Units Using Divisional Income, ROI, and Residual Income Colonial Pharmaceuticals is a small firm specializing in new products. It is organized into two divisions, which are based on the products they produce. AC Division is smaller and the life of the products it produces tend to be shorter than those produced by the larger SO Division. Selected financial data for the past year is shown below. Divisional investment is as of the beginning of the year. Colonial Pharmaceuticals uses a 9 percent cost of capital and uses beginning-of-the-year investment when computing ROI and residual income. Ignore income taxes.

	AC Division	SO Division
Sales	$       8,000	$   20,000
Cost of goods sold	3,200	7,000
Allocated corporate overhead	600	1,800
SG&A	700	1,530
R&D	2,000	3,600

Required

1. Compute divisional income for the two divisions.

2. Calculate the operating margin, which is equivalent to the return on sales, for the two divisions.

3. Calculate ROI for the two divisions.

4. Compute residual income for the two divisions. (My calculation for division SO is showing a negative number, please help)

5. Assess the financial performance of the two divisions based on your analysis.

Answer 1

1
	AC Division	SO Division
Divisional income	1980	5070
Divided by Divisional investment	9400	78000
ROI	21.06%	6.50%
2
	AC Division	SO Division
Divisional investment	9400	78000
X Cost of capital	10%	10%
Minimum required return	940	7800
Divisional income	1980	5070
Less: Minimum required return	940	7800
Residual income	1040	(2730)
Workings:
	AC Division	SO Division
Sales	8800	18000
Less:
Cost of goods sold	3240	6600
R&D	2200	3400
SG&A	760	1330
Allocated corp. overhead	620	1600
Divisional income	1980	5070