Exercise 11-12 Evaluating New Investments Using Return on Investment (ROI) and R

Question

Exercise 11-12 Evaluating New Investments Using Return on Investment (ROI) and Residual Income [LO11-1, LO11-2]

Selected sales and operating data for three divisions of different structural engineering firms are
given as follows:

Compute the return on investment (ROI) for each division using the formula stated in terms of margin and turnover. (Round your answers to 2 decimal places.)

2.

Compute the residual income (loss) for each division. (Loss amounts should be indicated by a minus sign. Round your "Required rate of return" to 2 decimal places.)

Assume that each division is presented with an investment opportunity that would yield a 21% rate of return.

  

If performance is being measured by ROI, which division or divisions will probably accept or reject the opportunity?

      

If performance is being measured by residual income, which division or divisions will probably accept or reject the opportunity?

+

Selected sales and operating data for three divisions of different structural engineering firms are
given as follows:

Division A Division B Division C   Sales $ 6,900,000 $ 10,900,000 $ 10,000,000   Average operating assets $ 1,725,000 $ 5,450,000 $ 2,500,000   Net operating income $ 414,000 $ 1,090,000 $ 325,000   Minimum required rate of return 19.00 % 20.00 % 16.00 % Required: 1.

Compute the return on investment (ROI) for each division using the formula stated in terms of margin and turnover. (Round your answers to 2 decimal places.)

Margin Turnover ROI Division A % % Division B % % Division C % %

2.

Compute the residual income (loss) for each division. (Loss amounts should be indicated by a minus sign. Round your "Required rate of return" to 2 decimal places.)

Division A Division B Division C Average operating assets Required rate of return % % % Required operating income Actual operating income Required operating income (above) Residual income (loss)

Explanation / Answer

1.

2.

3a.

3b.

Residual income of division A is positive, Accepted

Division b in 0, accept or indifferent

Division c is negative, rejected

A B C= A/B D E= B/D F= C*E Net income Sales Margin % Assets Turnover % ROI Division A       414,000            6,900,000 6.00%          1,725,000 4.00 24.00% Division B    1,090,000          10,900,000 10.00%          5,450,000 2.00 20.00% Division C       325,000          10,000,000 3.25%          2,500,000 4.00 13.00%

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