Question

Selected sales and operating data for three divisions of different structural engineering firms are given as follows: Sales Average operating assets Net operating income Minimum required rate of return Division A $5,500,000 $1,100,000 $ 253,000 15.00% Division B $9,500,000 $4,750,000 $ 817,000 17.20% Division C $8,600,000 $1,720,000 $ 159,100 12.00% Required: 1. Compute the return on investment (ROI) for each division using the formula stated in terms of margin and turnover. (Round your Turnover answers to 2 decimal places. Round your Margin and ROI percentage answers to 2 decimal places (i.e., 0.1234 should be entered as 12.34).) Margin Turnover ROI Division A Division B Division C % % % 1 % 2. Compute the residual income (loss) for each division. (Loss amounts should be indicated by a minus sign. Round your Required Rate of Return percentage answers to 2 decimal places (i.e., 0.1234 should be entered as 12.34).) Division A Division B Division C Average operating assets Required rate of return Required operating income Actual operating income Required operating income (above) Residual income (loss)

Answer 1

Ans. 1		Margin (a)	Turnover (b)	ROI (a*b)
	Division A	4.60%	5.00	23.00%
	Division B	8.60%	2.00	17.20%
	Division C	1.85%	5.00	9.25%
	*Calculations:
	Margin   =   Net operating income / Sales * 100
	Division A	$253,000 / $5,500,000 * 100		4.60%
	Division B	$817,000 / $9,500,000 * 100		8.60%
	Division C	$159,100 / $8,600,000 * 100		1.85%
	Turnover = Sales / Average operating assets
	Division A	$5,500,000 / $1,100,000		5.00	times
	Division B	$9,500,000 / $4,750,000		2.00	times
	Division C	$8,600,000 / $1,720,000		5.00	times
Ans. 2			Division A	Division B	Division C
	Average operating assets		$1,100,000	$4,750,000	$1,720,000
	Required rate of return		15%	17.20%	12%
	Required operating income		$165,000	$817,000	$206,400
	Actual operating income		$253,000	$817,000	$159,100
	Required operating income (above)		$165,000	$817,000	$206,400
	Residual income (loss)		$88,000	$0	-$47,300
	*Residual income is the difference between Actual operating income and Required operating income.
Ans. 3 a	Division A	Reject
	Division B	Reject
	Division C	Accept
	*Division C has the ROI of 9.25% which is less than the investment opportunity of 17%,
	and Division A or B has the exceed ROI rather than the investment opportunity, so the
	investment opportunity will be accepted by Division C to increase its profitability.
	If Division A or B accepts the opportunity then their profitability will reduce as they have
	already higher Return on their investments.
Ans. 3 b	Division A	Accept
	Division B	Reject
	Division C	Accept
	*If performance is being measured by residual income, then Divisions A & C will probably accept
	the opportunity because at present their minimum required rate of return is less than the investment
	opportunity.
	Division B would absolutely reject the opportunity because the 17% investment opportunity is less
	than its present minimum required rate of return (17.20%).