Wescott Company has three divisions: A, B, and C. The company has a hurdle rate

Question

Wescott Company has three divisions: A, B, and C. The company has a hurdle rate of 8 percent. Selected operating data for the three divisions are as follows: Division A Division B Division C Sales revenue $ 1,300,000 $ 1,091,000 $ 1,096,000 Cost of goods sold 803,000 801,000 796,000 Miscellaneous operating expenses 73,000 61,000 62,000 Interest and taxes 57,000 50,000 50,000 Average invested assets 9,857,000 2,353,000 3,870,000 Wescott is considering an expansion project in the upcoming year that will cost $5.9 million and return $543,000 per year. The project would be implemented by only one of the three divisions. Required: 1. Compute the ROI for each division. (Do not round your intermediate calculations. Round your percentages to 2 decimal places.) 2. Compute the residual income for each division. (Loss amounts should be indicated by a minus sign.) 3. Rank the divisions according to the ROI and residual income of each. 4-a. Compute the return on the proposed expansion project. (Round your percentages to 2 decimal places.) 4-b. Is this an acceptable project? Yes No 5. Without any additional calculations, state whether the proposed project would increase or decrease each division’s ROI and state whether the division manager would accept or reject the proposed project. 6. Compute the new ROI and residual income for each division if the project was implemented within that division. (Loss amounts should be indicated by a minus sign. Do not round your intermediate calculations. Round your percentages to 2 decimal places.)

Explanation / Answer

Division A Division B Division C Sales 1300000 1091000 1096000 Less:COGS 803000 801000 796000 Gross Margin 497000 290000 300000 Miss. Operating expenses 73000 61000 62000 Net Operating Income 424000 229000 238000 Interest & Taxes 57000 50000 50000 Net Income 367000 179000 188000 Average Invested Assets 9857000 2353000 3870000 Ans 1 ROI=NetOperating Profit/Average operating Investment *100 4.30 9.73 6.15 % Ans 2 Residual Income Net operating Income-(Minimum Required Return*Cost of Operating assets) 424000-(.08*9857000) 229000-(.08*2353000) 238000-(.08*387000) Residual Income -364560 40760 -71600 Ans 3 3 1 2 Ans 4 Return on new project .543 million/5.9*100 9.20 % Ans 4 b Yes it is an acceptable project Ans 5 Yes the project will increase each division ROI as it is more than each divisins ROI Yes the manager can accept the offer Ans 6 Division A Division B Division C Sales 1300000 1091000 1096000 Less:COGS 803000 801000 796000 Gross Margin 497000 290000 300000 Miss. Operating expenses 73000 61000 62000 Net Operating Income A 424000 229000 238000 Interest & Taxes 57000 50000 50000 Net Income 367000 179000 188000 Income from new projext B 543000 543000 543000 New Net operating Income C=A+B 967000 772000 781000 New Invested assets 5900000 5900000 5900000 Average Invested Assets 9857000 2353000 3870000 Total Invested Assets D 15757000 8253000 9770000 Ans 1 ROI=New NetOperating Profit/Total Average operating Investment *100 C/D*100 6.14 9.35 7.99 % Ans 2 Residual Income New Net operating Income-(Minimum Required Return*Cost of Operating assets) C-(.08*D) 967000*(.08*15757000) 772000-(.08*8253000) 781000-(.08*9770000) Residual Income -293560 111760 -600

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