Helena Corporation operates three investment centers. The following financial st

Question

Helena Corporation operates three investment centers. The following financial statements apply to the investment center named Bowman Division: BOWMAN DIVISION Income Statement For the Year Ended December 31, 2018 $138,000 78,000 60,000 Sales revenue Cost of goods sold Gross margin Operating expenses (6,000) Selling expenses Depreciation expense 8,000 46, 000 Operating income Nonoperating item Loss of sale of land(16,000) Net income 30,000 BOWMAN DIVISION Balance Sheet As of December 31, 2018 Assets Cash Accounts receivable Merchandise inventory Equipment less accumulated depreciation Nonoperating assets $ 18,898 42,266 37,578 90,258 9,000 $198,000 Total assets Liabilities Accounts payable Notes payable $ 9,637 72,000 Stockholders' eguity Common stock Retained earnings 80,000 36,363 $198,000 Total liabilities and stockholder s equity Required c. Calculate the ROI for Bowman. d. Helena has a desired ROl of 10 percent. Headquarters has $96,000 of funds to assign to its investment centers. The manager of the Bowman Division has an opportunity to invest the funds at an ROI of 12 percent. The other two divisions have investment opportunities that yield only 11 percent. Calculate the new ROl for Bowman division, if the investment opportunity is adopted by Bowman. e. Based on the original data, calculate the original residual income. Also, calculate the new residual income based on information provided in Requirement d.

Explanation / Answer

Part c

Operating assets = Total assets - Non-operating assets ($198,000 - $9,000)

ROI = Operating income / Operating assets = $46,000 / $189,000 = 24.34%

Part d

Since the rate of return on the investment opportunity (12 percent) is below Helena’s current ROI (24.34 percent), accepting the opportunity would decrease Helena’s average ROI, which would have a negative effect on the manager’s performance evaluation. While it is to the advantage of the company as a whole for Helena to accept the investment opportunity, it will reflect negatively on the manager to do so. This phenomenon is called suboptimization.

Part e

Original Residual Income

Residual income = Operating income - (Operating assets x Desired ROI)

Residual income = $46,000 - ($189,000 x .10)

Residual income = $46,000 - $18,900

Residual income = $27,100

Operating income from the investment opportunity is $11,520 ($96,000 x .12)

Residual income = New Operating income - (New aOperating assets x Desired ROI)

Residual income = $57,520 - ($285,000 x .10)

Residual income = $57,520 - $28,500

Residual income = $29,020

Since the investment opportunity would increase Helena’s residual income, the acceptance of the opportunity would improve the manager’s performance evaluation, thereby motivating the manager to accept it.

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