Question

Chapter 10 Question 2:

Selected sales and operating data for three divisions of different structural engineering firms are given as follows:

	Division A			Division B			Division C
Sales	$	6,800,000		$	10,800,000		$	9,900,000
Average operating assets	$	1,360,000		$	2,700,000		$	1,980,000
Net operating income	$	401,200		$	1,069,200		$	311,850
Minimum required rate of return		23.00	%		39.60	%		20.00	%

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 25% 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.

Returnon investment = Net income/ Average operating Assets

Division A =$401,200/$1,360,000=29.50%

Division B =$1,069,200/$2,700,000=39.60%

Division C =$311,850/$1,980,000=15.75%

2.

Residual income = Net operating income- minimum required return

Division A =$401,200-$312,800($1,360,000×23%)

=$88,400

Division B =$1,069,200-$1,069,200($2,700,000×39.60%)

=$0

Division C =$311,850-$396,000($1,980,000×20%)

=($84,150)

3.

A. Division C will accept as it is less ROI than 25% , so it increases the overall ROI of Division C

B. Both Division A and C accept the opportunity as required return is less than 25%

_____×____₹