Question

Selected sales and operating data for three divisions of different structural engineering firms are given as follows: Division A Division B Division C Sales $ 15,300,000 $ 35,300,000 $ 20,240,000 Average operating assets $ 3,060,000 $ 7,060,000 $ 5,060,000 Net operating income $ 703,800 $ 529,500 $ 526,240 Minimum required rate of return 9.00 % 9.50 % 10.40 % 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?

Answer 1

Answer:

Divisions                                              A                  B                         C

1) ROI                                                     23%              7.50%               10.40%

2) Residual income(loss)                    $428400    -$141200               $0        

3)a ROI                                                 reject            accept               reject  

3b) Residual income                         Accept            Reject             Accept      

Explanation:

Divisions                                              A                  B                         C

Sales                                           $15,300,000   $35,300,000     $20,240,000

Net operating income                 $703,800        $529,500          $526,240

operating Assets                         $3,060,000     $7,060,000      $5,060,000

required rate of return                 9.00%                9.50%                  10.40

ROI = Net operating income / average operating assets

Residual income(loss) = controllable margin- required return* average operating expenses

 let controllable margin = net operating income

sales are primary incomes more like gross without any expenses deducted.

3a ) If performance is measured by ROI then the new rate of the investment must be higher than the ROI for a project to be accepted

3b) Residual income: for a project to be accepted it must have a positive effect on it and or should generate a positive residual income.