Selected sales and operating data for three divisions of different structural en

Question

Selected sales and operating data for three divisions of different structural engineering firms are given as follows:

    

Required:

1. Compute the return on investment (ROI) for each division using the formula stated in terms of margin and turnover. (Round your answers to 2 decimal places.)

2. Compute the residual income (loss) for each division. (Loss amounts should be indicated by a minus sign. Round your "Required rate of return" to 2 decimal places.)

3. Assume that each division is presented with an investment opportunity that would yield a 21% rate of return.

a. If performance is being measured by ROI, which division or divisions will probably accept or reject the opportunity?

b. If performance is being measured by residual income, which division or divisions will probably accept or reject the opportunity?

Division A Division B Division C Sales $ 6,900,000 $ 10,900,000 $ 10,000,000 Average operating assets $ 1,725,000 $ 5,450,000 $ 2,500,000 Net operating income $ 414,000 $ 1,090,000 $ 325,000 Minimum required rate of return 19.00 % 20.00 % 16.00 %

Explanation / Answer

Solution 1:

Solution 2:

Solution 3a:

If performance is being measured by ROI then Division B and Division C will accept the opportunity as there current ROI is below level 21% and accepting investment opportunity will increase overall ROI for division B and division C.

Further Division A will not accept the investment opportunity as it will result in decrease in overall ROI for division A as its exisitng ROI is higher than 21%

Solution b:

If performance is being measured by residual income, then all division will accept the investment opportunity as return offered by investment opportunity is higher than minimum required return for all divisions. Thus it wil increase Residual income for all the divisions.

Profit Margin Particulars Choose Numerator / Choose denomerator = Profit Margin Details Amount Details Amount Division A Operating Income $414,000.00 Sales $6,900,000.00 6.00% Division B Operating Income $1,090,000.00 Sales $10,900,000.00 10.00% Division C Operating Income $325,000.00 Sales $10,000,000.00 3.25%

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