Question

# Harbor Division has total assets (net of accumulated depreciation) of \$630,000 at the beginning of year...

Harbor Division has total assets (net of accumulated depreciation) of \$630,000 at the beginning of year 1. Harbor also leases a machine for \$18,000 annually. Expected divisional income in year 1 is \$82,000 including \$5,400 in income generated by the leased machine (after the lease payment). Harbor’s cost of capital is 9 percent. Harbor can cancel the lease on the machine without penalty at any time and is considering disposing of it today (the beginning of year 1).

Required:

a. Harbor computes ROI using beginning-of-the-year net assets. What will the divisional ROI be for year 1 assuming Harbor retains the leased machine? (Enter your answer as a percentage rounded to 1 decimal place (i.e., 32.1).)

b. What would divisional ROI be for year 1 assuming Harbor disposes of the leased machine? (Enter your answer as a percentage rounded to 1 decimal place (i.e., 32.1).)

c. Harbor computes residual income using beginning-of-the-year net assets. What will the divisional residual income be for year 1 assuming Harbor retains the leased machine?

d. What would divisional residual income be for year 1 assuming Harbor disposes of the leased machine?

Ans:

1. Divisional ROI= After-tax Income/Divisional Assets

=> 82,000/630,000*100

=> 13.01%

2. Divisional ROI be for year 1 assuming Harbor disposes of the leased machine:

Expected Divisional income for Year 1= 82,000-5,400

=> \$76,600

Return On Investment= 76,600/630,000*100

=> 12.16%

3. Residual Income of harbor Division for Year 1 Assuming Harbor Division Disposes of the Assets for its book Value

Cost of Invested Capital= Cost of capital * Divisional Assets

=> 630,000*9%

=> \$56,700

Residual Income= After tax Income- Cost of invested Capital

=> 82,000-56,700

=> \$25,300

4. Divisional residual income be for year 1 assuming Harbor disposes of the leased machine:

Residual Income= Net operating Income- (Required Return*net operating assets)

=> 76,600-{630,000*9%}

=> 76,600- 56,700

=> \$19,900