Chapter 1 Wesoott Company has three divisions: A, B, and C. The company has a hu

Question

Chapter 1 Wesoott Company has three divisions: A, B, and C. The company has a hurdle rate of 8 peroent. Se operating data for the three divisions are as follows Cost of goods sold Interest and taxes Average invested assets $ 1,255,000 $ 920,000 898,000 776,000675,000652,000 000 52,00053,100 48,00041,00041,500 ,300,000 1,930,000 3,215,000 4,0 Wesoott is considering an expansion project in the upooming year that will cost $5 million and return $450,000 per year. The project would be implemented by only one of the three divisions Required: 1. Compute the ROl for each division. (Do not round your intermediate calculations ) Division A Division E Division C Compute the residual income for aach divison aoss amounts should be indicated by a minus Division A Division B Division C

Explanation / Answer

(2) compute residual income

residual income = operating income - ( desired ROI * average asset investment )

first of lets calculate operating income , it is sales - cost of goods sold - other operating expense but before intt and taxes

                                             div A                                         div b                                       div C

Sales revenue              $1,255,000                                   920,000                                   898,000

cost of goods sold          (776,000)                                 (675,000)                                  (652,000)

misc operating exp            (64,000)                                  (52,000)                                     (53,100)

operating income           $ 415,000                                   $193000                                    $ 192,900

hurdle rate is the required rate of return

So ROI desired                8%

Average assest invest   $8,300,000                            $1,930,000                                       3,215,000

Residual income for div A = $415,000 - (8% * 8,300,000)

                                           = $(249,000)

                       

                                  div b = 193,000 - ( 8% * 1,930,000)

                                          = $38,600

                                   Div c = 192,900 - ( 8% * 3,215,000)

                                            = $(64,300)

(6) ROI = change in profits / average capital investment

             = $450,000 + 415,000/ 8,300,000 + 5000,000 = 6.50%

DIVB

    = $450,000 + 193,000/ 1930,000+ 5000,000  = 9.28%

DivC

= $450,000 +192,900/ 500,000+3,215,000 =   7.83%

new residual income

Div A = 865,000 - ( 8% * 13,300,000)

          = ($199,000)

Div B = 643,000 - ( 8% * 6930,000)

         = $88,600

Div C = 642,900 - ( 8% * 8,215,000)

          = ($14,300)

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