Question

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?

Answer #1

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

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