Selected sales and operating data tor three divisions ot ditterent structural en

Question

Selected sales and operating data tor three divisions ot ditterent structural engineering tirms are given as tollows: Sales Average operating assets Net operating income Minimum required rate of return Division A Division B Division c $12,560,000 35,700,000 $20,560,000 $ 3,140,000 7,140,000 5,140,000 $577,760 428,400 S555, 120 10.80 7.00% 7.501 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 8% 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? Complete this question by entering your answers in the tabs below. Req 1 Req 2 Req 3A Reg 38 Compute the return on investment (ROl) 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.) ROI Margin umover Division A Division B Division C

Explanation / Answer

1) computing Return on investment
ROI = Margin × Turnover
Margin = Net operating income/ sales
Turnover= sales/ average operating assets

                       Margin                  turnover                      ROI
Division A       4.6 %           ×          4                        =       18.4%
Division B       1.2 %           ×          5                        =         6%
Division C        2.7 %           ×          4                       =       10.8%

DIVISION A
MARGIN        = 577,760/ 12,560,000 =   4.6%
TURNOVER    =12,560,000/3,140,000 = 4


DIVISION B
MARGIN      = 428,400/ 35,700,000 =    1.2%
TURNOVER   = 35,700,000/ 7,140,000= 5


DIVISION C
MARGIN       = 555,120/20,560,000 = 2.7%
TURNOVER   = 20,560,000/ 5,140,000 = 4

2) computation of residual income ( loss)
Residual income = Net operating income- charge for use of capital
Residual income= Net operating income -(average operating assets × minimum required rate of return)

                                 Division A          Division B      Division C
Net operating      $577,760             $428,400      $555,120
income
Charge for use    ($2,19,800)     ($5,35,500)     ($555,120)
of capital
RESIDUAL              $3,57,960         ($1,07,100)      0
INCOME

Division A
Charge for use capital =$3,140,000× 7% =$2,19,800

Division B
Charge for use capital = $7,140,000× 7.5% = $5,35,500

Division C
Charge for use capital= $5,140,000×10.8% = $555,120

3) a

                                       Division A      Division B     Division C
Return on investment   18.4%              6%               10.8%
Therefore, if the division
is presented with an
investment opportunity
yielding 8%, it probably      Reject       Accept        Reject

3) b


                                        Division A      Division B     Division C
Minimum required              7%                 7.5%           10.8%
rate For computing
residual Income
Therefore, if the division
is presented with an
investment opportunity
yielding 8%, it probably      Accept     Accept        Reject

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