Question

Yard Products Company Chapter 10 Below is an income statement for the most recently ended year for the Yard Products Company and its two divisions Shovel Ное Co. Total Sales Variable Costs. Contribution Margin Segment Fixed Costs. Corporate Fixed Costs Net Income. $1,500,000 (850,000) $900,000 $600,000 (500,000) (350,000) 400,000 250,000 650,000 (350,000) (250,000) (120,000) 30,000 (100,000) ( 80,000) 70,000 (200,000) 100,000 $400,000 200,000 600,000 Segment average assets.. Corporate average assets. Total average assets. $500,000 $900,000 500,000 1,400,000 300,000 800,000 The president of the company has severely criticized the manager of the Shovel Division for its dismal 3.8% ROI, "which doesn't come close to the firm's 12% cost of capital." The manager of Hoe Division also was criticized for an 11.7% ROI, "which is slightly less than the cost of capital." Corporate fixed costs and assets are allocated to each division on the basis of sales Required Show the calculations that the president used as the basis for the criticism. b. For each division and for the company as a whole, using appropriate data, calculate the following: a a. Return on Sales b. Investment Turnover c. ROI Calculate residual income for each division. C d. In view of your answers to parts (b) and (c), is the president's criticism justified?

Answer 1

a	The Preisdent of the company has applied the following formulae for calculation of ROI
	ROI =Net Income / Average Assets
	ROI of Shovel =$30,000 / $800,000 =3.75 % or 3.80%
	ROI of Hoe =$70,000 / $600,000 =11.67% or 11.70%
	The cost of capital of the company is 12% and since the ROI of both division is less than Cost of capital hence president has criticized.
b	Return on sales =Net operating income / Net Sales
	Investment Turnover =Net sales / Average Operating Assets
	ROI =Margin*Turnover =6%*2 =12%
	Return on sales of Shovel =$30,000 / $900,000 =3.33%	Return on sales of Hoe =$70,000 / $600,000 =11.67%	Return on sales of Company =$100,000 / $1,500,000 =6.67%
	Investment Turnover of Shovel =$900,000 / $800,000 =1.125	Investment Turnover of Hoe =$600,000 / $600,000 =1.00	Investment Turnover of Company =$1,500,000 / $1,400,000 =1.07
	ROI of Shovel =3.33%*1.125 =3.75%	ROI of Shovel =11.67%*1.00 =11.67%	ROI of Shovel =6.67%*1.07 =7.14%
c	Residual income =Net operating income -(Average operating assets*12.00%)
	Residual income of Shovel =$30,000 - ($800,000*12%) =($66,000)
	Residual income of Hoe =$70,000 - ($600,000*12%) =($2,000)
d	Yes the Presiddent criticsm is justified as the Residual income of both the division is negative