Rains Nickless Ltd. has 2 divisions. Selected data on the 2 divisions follow: Pe
ID: 2471293 • Letter: R
Question
Rains Nickless Ltd. has 2 divisions. Selected data on the 2 divisions follow:
Perth
Darwin
Sales
$9,000,000
$20,000,000
Net Operating Income
$630,000
$1,800,000
Average operating assets
$3,000,000
$10,000,000
Required:
1) Compute the return on investment.
2) Assume that the company evaluates performance using residual income and that the minimum required rate of return for any division is 16%. Compute the residual income for each division.
3) Is the Darwin Division's greater residual income an indication that it is better managed? Explain.
Perth
Darwin
Sales
$9,000,000
$20,000,000
Net Operating Income
$630,000
$1,800,000
Average operating assets
$3,000,000
$10,000,000
Explanation / Answer
Return on investment=Net income/Investment * 100
Perth
ROI=630000/3000000*100=21%
Darwin
ROI=1800000/10000000*100=18%
Residual income is the portion of profit above the required of return
Required rate of return=16%
Perth
Required return=16/100*3000000=480000
Residual income=Profit-Required return=630000-480000=150000
Darwin
Required return=16/100*10000000=1600000
Residual income=1800000-1600000=200000
On the basis of Residual income Darwin is better managed as it is able to provide a better residual income as compared to Perth.
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