Question

Responsibility Accounting and Performance Evaluation 136: Learning Objective 4 P24-22A Using ROI and RI to evaluate investment centers Woll Prints is a national paint manufacturer and retailer. The company is segmented into five divisions: Paint Stores (branded retail locations), Consumer (paint sold through home improvement stores), Automotive (sales to auto manufacturers), Inter- national, and Administration. The following is selected divisional information for its two largest divisions: Paint Stores and Consumer. 4. Paint Stores's ROI 34.49% Net Sales Revenue Operating Income Average Total Assets Paint Stores Consumer $ 3,980,000 1,315,000 $476,000 195,000 $1,380,000 1,600,000 Management has specified a 21% target rate of return. Requirements 1. Calculate each division's ROI. Round all of your answers to four decimal places. 2. Calculate each division's profit margin ratio. Interpret your results. 3. Calculate each division's asset turnover ratio. Interpret your results. 4. Use the expanded ROI formula to confirm your results from Requirement 1. Interpret your results. 5. Calculate each division's RI. Interpret your results, and offer a recommendation for any division with negative RI. 6. Describe some of the factors that management considers when setting its minimum target rate of return.

Answer 1

Answer to Requirement 1:

Paint Stores:

Return on Investment = Operating Income / Average Total Assets
Return on Investment = $476,000 / $1,380,000
Return on Investment = 0.3449

Consumer:

Return on Investment = Operating Income / Average Total Assets
Return on Investment = $195,000 / $1,600,000
Return on Investment = 0.1219

Answer to Requirement 2:

Paint Stores:

Profit Margin Ratio = Operating Income / Net Sales Revenue
Profit Margin Ratio = $476,000 / $3,980,000
Profit Margin Ratio = 0.1196

Consumer:

Profit Margin Ratio = Operating Income / Net Sales Revenue
Profit Margin Ratio = $195,000 / $1,315,000
Profit Margin Ratio = 0.1483

Consumer division is earning higher profit per net sales revenue than paint store division.

Answer to Requirement 3:

Paint Stores:

Asset Turnover Ratio = Net Sales Revenue / Average Total Assets
Asset Turnover Ratio = $3,980,000 / $1,380,000
Asset Turnover Ratio = 2.8841

Consumer:

Asset Turnover Ratio = Net Sales Revenue / Average Total Assets
Asset Turnover Ratio = $1,315,000 / $1,600,000
Asset Turnover Ratio = 0.8219

Paint stores division is generating more sales revenue per average total assets than consumer division.

Answer to Requirement 4:

Paint Stores:

Return on Investment = Profit Margin * Asset Turnover Ratio
Return on Investment = 0.1196 * 2.8841
Return on Investment = 0.3449

Consumer:

Return on Investment = Profit Margin * Asset Turnover Ratio
Return on Investment = 0.1483 * 0.8219
Return on Investment = 0.1219

Although consumer division is earning more profit than paint stores division, the paint stores division is generating more return on investment than consumer division.

Answer to Requirement 5:

Paint Stores:

Residual Income = Operating Income - Target Rate of Return * Average Total Assets
Residual Income = $476,000 - 0.21 * $1,380,000
Residual Income = $186,200

Consumer:

Residual Income = Operating Income - Target Rate of Return * Average Total Assets
Residual Income = $195,000 - 0.21 * $1,600,000
Residual Income = -$141,000

Paint stores division is earnings more income than the expected income.

Answer to Requirement 6:

The management should consider the following factors when setting its minimum target rate of return:
Average investment in division
Operating income
Desired residual income.