Using ROI and RI to evaluate investment centers Benjamin Doore is a national pai

Question

Using ROI and RI to evaluate investment centers Benjamin Doore is a national paint manufacturer and retailer. The company is segmented into five divisions: Paint Stores (branded retail locations), Consumer (paint sold through home improvement stores), Automotive (sales to auto manufacturers), International, and Administration. The following is selected divisional information for its two largest divisions: Paint Stores and Consumer: Net Sales Operating
Income Average
Total Assets Paint Stores $        4,010,000 $        482,000 $        1,385,000 Consumer            1,280,000            185,000            1,585,000 Management has specified a 19% target rate of return. Requirements 1.) Calculate each division's ROI. Round all of your answers to four decimal places. 2.) Calculate each division's profit margin ratio. Interpret your results. 3.) Calculate each division's asset turnover ratio. Interpret your results. 4.) Use the expanded ROI formula to confirm your results from Requirement 1. Interpret your results. 5.) Calculate each division's RI. Interpret your results. Offer a recommendation for any division with negative RI. 6.) Describe some of the factors that management considers when setting its minimum target rate of return. Using ROI and RI to evaluate investment centers Benjamin Doore is a national paint manufacturer and retailer. The company is segmented into five divisions: Paint Stores (branded retail locations), Consumer (paint sold through home improvement stores), Automotive (sales to auto manufacturers), International, and Administration. The following is selected divisional information for its two largest divisions: Paint Stores and Consumer: Net Sales Operating
Income Average
Total Assets Paint Stores $        4,010,000 $        482,000 $        1,385,000 Consumer            1,280,000            185,000            1,585,000 Management has specified a 19% target rate of return. Requirements 1.) Calculate each division's ROI. Round all of your answers to four decimal places. 2.) Calculate each division's profit margin ratio. Interpret your results. 3.) Calculate each division's asset turnover ratio. Interpret your results. 4.) Use the expanded ROI formula to confirm your results from Requirement 1. Interpret your results. 5.) Calculate each division's RI. Interpret your results. Offer a recommendation for any division with negative RI. 6.) Describe some of the factors that management considers when setting its minimum target rate of return.

Explanation / Answer

Answer:

1

Calculate each division's ROI. Round all of your answers to four decimal places.

ROI =

=Operating income / average total assets

Operating

Average

Income

Total Assets

ROI

A

B

C= A/B

Paint Stores

482000

1385000

34.80%

Consumer

185000

1585000

11.67%

So ROI for both is a sunder

ROI

Paint Stores

34.80%

Consumer

11.67%

_________________________________________________

2

Calculate each division's profit margin ratio. Interpret your results

profit margin ratio

=Operating income/ net sales

Operating

Net Sales

Income

Profit
Margin

A

B

C= A/B

Paint Stores

482000

4,010,000

12.02%

Consumer

185000

1,280,000

14.45%

Profit margin

Paint Stores

12.02%

Consumer

14.45%

_ The Consumer Division is more profitable on each unit of sales by 2.43%. ____________________________________________

3

Calculate each division's asset turnover ratio. Interpret your results

division's asset turnover ratio

=Net sales / Average total assets

Net Sales

Average

Assets
turn over

Total Assets

A

B

C= A/B

Paint Stores

4,010,000

1,385,000

2.8953

Consumer

1,280,000

1,585,000

0.8076

Assets
turn over

Paint Stores

2.8953

Consumer

0.8076

The Paint Stores Division is more efficient in generating sales with its average total assets.

_________________________________________________

4

Use the expanded ROI formula to confirm your results from Requirement 1. Interpret your results.

Profit margin

x

Assets
turn over

ROI

A

B

C=A*B

Paint Stores

12.0%

x

2.8953

34.80%

Consumer

14.5%

x

0.8076

11.67%

Even though the Paint Stores Division has a lower profit margin than the Consumer Division, its higher asset turnover ratio caused it to have a much higher ROI.

____________________________________________________

5

Calculate each division's RI. Interpret your results. Offer a recommendation for any division with negative RI.

RI      =      Operating income     –     (Target rate of return × Average total assets)

Operating
income

Target
Return

x

Average
Total Assets

Traget
income

Residual
income

A

B

C

D=B*C

E=A-D

Paint Stores

482000

19%

x

1,385,000

263150

218850

Consumer

185000

19%

x

1,585,000

301150

-116150

Residual
income

Paint Stores

218850

Consumer

-116150

Only the Paint Stores Division is meeting management’s target rate of return. The Consumer Division has a negative residual income; they should either look into eliminating nonproductive assets or work at generating more operating income. To generate more operating income they may need to reduce product costs or selling and administrative costs or increase sales

_________________________________________

6

Management may have different minimum target rates of return for different divisions. For example, management might require a higher target rate of return from a division operating in a riskier business environment. Management also will need to consider interest rates on the company debt, investors’ expectations, competitors’ rates of return, other divisions’ rates of return, and general economic conditions.

Operating

Average

Income

Total Assets

ROI

A

B

C= A/B

Paint Stores

482000

1385000

34.80%

Consumer

185000

1585000

11.67%

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