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.

2. Compute the residual income (loss) for each division.

3. Assume that each division is presented with an investment opportunity that would yield a 10% 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?

Req 1

Req 2

Req 3A

Req 3B

Compute the return on investment (ROI) for each division using the formula stated in terms of margin and turnover. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

indicated by a minus sign.)

Assume that each division is presented with an investment opportunity that would yield a 10% rate of return. If performance is being measured by ROI, which division or divisions will probably accept or reject the opportunity?

Assume that each division is presented with an investment opportunity that would yield a 10% rate of return. 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 $ 16,000,000 $ 36,000,000 $ 20,800,000 Average operating assets $ 3,200,000 $ 7,200,000 $ 5,200,000 Net operating income $ 752,000 $ 576,000 $ 540,800 Minimum required rate of return 9.00 % 9.50 % 10.40 %

Explanation / Answer

Answer 1 )

ROI = Margin * Turnover

Where Margin = Net operating income / Sales ; Turnover = Sales / Average operating assets

Answer 2)

Residual income = Net operating income - (Average operating assets * Minimum required rate of return)

Answer 3a

Explanation : If performance is being measured by ROI , Division A & C will reject  investment opportunity as their respective ROI is greater that the yield from  investment opportunity ie 10 %. Accordingly Division B will accept as its ROI is less the  the yield from  investment opportunity ie 10 %

Answer 3b

Explanation : If performance is being measured by Residual income , Division A & B will accept the investment opportunity as their respective required rate of return is less than the yield from  investment opportunity ie 10 %. Accordingly Division C will reject as its required rate of return is greater the  the yield from  investment opportunity ie 10 %

Margin Turnover ROI Division A $752,000 /$16,000,000 = 4.70% $16,000,000 /$3,200,000 = 5 23.5% Division B $576,000 / $36,000,000 = 1.6% $36,000,000 /$7,200,000 = 5 8% Division C $540,800 / $20,800,000 =2.6 % $20,800,000 /$5,200,000 = 4 10.40%

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