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 $ 15,650,000 $ 35,650,000 $ 20,520,000 Average operating assets $ 3,130,000 $ 7,130,000 $ 5,130,000 Net operating income $ 719,900 $ 499,100 $ 595,080 Minimum required rate of return 8.00 % 8.50 % 11.60 % 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 9% rate of return. a. If performance is being measured by ROI, which division or divisions will probably accept or reject the opportunity

Answer 1

Answer:

1. ROI for each division:

                                                   Division A       Division B       Division C

Return on investment (DuPont) =       23%                   7%                 11.6%

2. Residual income (loss)           $469,500      ($106,950)        $0

3. Divisions A and C will probably accept the opportunity while Division B will reject it.

Explanation:

a) Data and Calculations:

                                                   Division A       Division B       Division C

Sales                                       $ 15,650,000  $ 35,650,000  $ 20,520,000

Average operating assets       $ 3,130,000      $ 7,130,000     $ 5,130,000

Net operating income                 $ 719,900        $ 499,100        $ 595,080

Minimum required rate of return     8.00 %             8.50 %              11.60 %

Return on investment (ROI) (ordinary) 23%                   7%                 11.6%

ROI = Net operating income/Average operating assets * 100

Return on investment (DuPont ROI) :

Asset Turnover =                                   5                     5                      4

Sales/Average operating assets

Operating income margin =

Income/Sales * 100                             4.6%                 1.4%                  2.9%

Return on investment (DuPont) =       23%                   7%                 11.6%

Asset Turnover * Operating income margin

Residual income =  

Net income - (Equity * RRR)             $469,500      ($106,950)     $0

NB: Equity is approximated to the net operating asset here.