Company wants to be more vertically integrated and considering the purchase of o

Question

Company  wants to be more vertically integrated and considering the purchase of one or more of the companies in its supply chain.  Calculate the ROI and residual income for each company.  Show all work.  

                                                                    ____________         Company___________________

                                                                    _____A_____         _____B_____          ____  C_____  

    Sales                                                          $3,600,000              $5,000,000                 $1,500,000

    Net Operating Income                                    240,000                  220,000                        96,000

   Average Operating Assets                            1,200,000               2,000,000                      800,000

   Minimum required rate of return:                     10%                          8%                             14%

Explanation / Answer

Hi,

Please find the answer as follows:

Company A

Return on Investment = Net Operating Income/Average Operating Assets*100 = 240000/1200000*100 = 20%

Residual Income = Operating Income - Operating Assets*Required Rate of Return = 240000 - 1200000*.10 = 120000

Company B

Return on Investment = Net Operating Income/Average Operating Assets*100 = 220000/2000000*100 = 11%

Residual Income = Operating Income - Operating Assets*Required Rate of Return = 220000 - 2000000*.08 = 60000

Company C

Return on Investment = Net Operating Income/Average Operating Assets*100 = 96000/800000*100 = 12%

Residual Income = Operating Income - Operating Assets*Required Rate of Return = 96000 - 800000*.14 = -16000

Thanks.

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