The vice president of operations of Pavone Company is evaluating the performance
ID: 2475102 • Letter: T
Question
The vice president of operations of Pavone Company is evaluating the performance of two divisions organized as investment centers. Invested assets and condensed income statement data for the past year for each division are as follows: Business Division Consumer Division Sales $2,500,000 $2,550,000 Cost of goods sold 1,320,000 1,350,000 Operating expenses 930,000 843,000 Invested assets 1,250,000 2,125,000 Required: 1. Prepare condensed divisional income statements for the year ended December 31, 2016, assuming that there were no service department charges. 2. Using the DuPont formula for rate of return on investment, determine the profit margin, investment turnover, and rate of return on investment for each division. If required, round your final answer to one decimal place. 3. If management desires a minimum acceptable rate of return of 17%, determine the residual income for each division. Use the minus sign to indicate a negative income. 4. Discuss the evaluation of the two divisions, using the performance measures previously determined.
Explanation / Answer
4.
On the basis of income from operations, the Consumer Division generated $107,000 ($357,000 – $250,000) more income from operations than did the Business Division. However, income from operations does not consider the amount of invested assets in each division. On the basis of the rate of return on investment, the Business Division earned 20 cents (20.0%) on each dollar of invested assets, while the Consumer Division earned only 16.8 cents (16.8%) on each dollar of invested assets. Although the Consumer Division has a higher profit margin than the Business Division (14.0% vs. 10.0%), the Business Division has a higher investment turnover (2.0 vs. 1.2), which generated its higher rate of return on investment. Residual income can be viewed as a combination of the preceding two performance measures. Residual income considers the absolute dollar amount of income from operations generated by each division and also considers a minimum rate of return to be earned by each division. On the basis of residual income, the Business Division is the only profitable division.
Business DIV ConsumerDIV Sales 2,500,000 2,550,000 Cost of goods sold 1,320,000 1,350,000 Gross profit 1,180,000 1,200,000 Operating expenses 9,30,000 843,000 Income from operations 250000 357000
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.