Wescott Company has three divisions: A, B, and C. The company has a hurdle rate
ID: 2531514 • Letter: W
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 Cost of goods sold Miscellaneous operating expenses Interest and taxes Average invested assets $ 1,275,000 S 996,000$ 988,000 716,000 57,000 45,000 3,485,000 788,000 68,000 52,000 8,992,000 731,000 56,000 45,000 2,118,000 Wescott is considering an expansion project in the upcoming year that will cost $5.4 million and return $488,000 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 percentage answer to 2 decimal places, (i.e. 0.1234 should be entered as 12.34%.)) ROI Division A Division B Division C 2. Compute the residual income for each division. (Loss amounts should be indicated by a minus sign.) Residual i Division A Division B Division CExplanation / Answer
1.
Before going into ROI the net income of each division should be calculated first.
Net income of Div A = Sales – Cost of goods sold – Operating expenses – Interest and taxes
= 1,275,000 – 788,000 – 68,000 – 52,000
= $367,000
Net income of Div B = Sales – Cost of goods sold – Operating expenses – Interest and taxes
= 996,000 – 731,000 – 56,000 – 45,000
= $164,000
Net income of Div C = Sales – Cost of goods sold – Operating expenses – Interest and taxes
= 986,000 – 716,000 – 57,000 – 45,000
= $168,000
ROI of Div A = (Net income / Average investment) × 100
= ($367,000 / 8,992,000) × 100
= 4.08 % [Answer]
ROI of Div B = (Net income / Average investment) × 100
= ($164,000 / 2,118,000) × 100
= 7.74 % [Answer]
ROI of Div C = (Net income / Average investment) × 100
= ($168,000 / 3,485,000) × 100
= 4.82 % [Answer]
2.
Before going into residual income the net operating income of each division should be calculated first.
Net operating income of Div A = Sales – Cost of goods sold – Operating expenses
= 1,275,000 – 788,000 – 68,000
= 419,000
Net operating income of Div B = Sales – Cost of goods sold – Operating expenses
= 996,000 – 731,000 – 56,000
= 209,000
Net operating income of Div C = Sales – Cost of goods sold – Operating expenses
= 986,000 – 716,000 – 57,000
= 213,000
Residual income of Div A = Net operating income – (Average investment × Hurdle rate)
= 419,000 – (8,992,000 × 8%)
= 419,000 – 719,360
= -300,360 [Answer]
Residual income of Div B = Net operating income – (Average investment × Hurdle rate)
= 209,000 – (2,118,000 × 8%)
= 209,000 – 169,440
= 39,560 [Answer]
Residual income of Div C = Net operating income – (Average investment × Hurdle rate)
= 213,000 – (3,485,000 × 8%)
= 213,000 – 278,800
= -65,800 [Answer]
3.
This ranking is based on higher ROI and residual income to lower ROI and residual income.
Div B has the highest ROI and residual income; therefore, this should be ranked 1st. Div A has the lowest ROI and residual income; therefore, this should be ranked 3rd. The rest, Div C, is in between; therefore, should be ranked 2nd.
Div A
3
Div B
1
Div C
2
4a.
Required return = (Return / Cost) × 100
= (488,000 / 5,400,000) × 100
= 9.04 %
4b.
This is an acceptable project, since the required return (9.04 %) is higher than the hurdle rate (8 %).
Div A
3
Div B
1
Div C
2
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.