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 $ 5,100,000 $ 9,100,000 $ 8,200,000 Average operating assets $ 1,020,000 $ 2,275,000 $ 1,640,000 Net operating income $ 214,200 $ 746,200 $ 118,900 Minimum required rate of return 17.00 % 32.80 % 14.00 % 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 19% 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

1. Return on Investment = Net operating income (NOI)/Average operating assets (AOA) * 100

Division A = 21%

Division B = 32.8%

Division C = 7.25%

2. Residual income (loss) = Operating Income - (Operating Assets x Target Rate of Return)

Division A = $40,800

Division B = $0

Division C = ($110,700)

3-a. If performance is being measured by ROI, Divisions A and C will accept the opportunity, while Division B will reject it because the actual rate of return of 19% is less than the minimum required rate of return of 32.8%.

3-b. Divisions A and C will accept the opportunity, while Division B will reject it.

Step-by-step explanation:

a) Data and Calculations:

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

Division A Division B Division C

Sales $ 5,100,000 $ 9,100,000 $ 8,200,000

Average operating assets $ 1,020,000 $ 2,275,000 $ 1,640,000

Net operating income $ 214,200 $ 746,200 $ 118,900

Minimum required rate of return 17.00 % 32.80 % 14.00 %

1. Return on Investment = Net operating income (NOI)/Average operating assets (AOA) * 100

= 21% 32.8% 7.25%

Division A = 21% ($214,200/$1,020,000 * 100)

Division B = 32.8% ($746,200/$2,275,000 * 100)

Division C = 7.25% ( $118,900/$1,640,000 * 100)

2. Residual income (loss) = Operating Income - (Operating Assets x Target Rate of Return)

Division A = $40,800 ($214,200 - ($1,020,000 * 17%) )

Division B = $0 ($746,200 - ($2,275,000 * 32.8%))

Division C =($110,700) ( $118,900 - ($1,640,000 * 14%))

Investment opportunity that would yield a 19% rate of return:

Division A Division B Division C

Sales $ 5,100,000 $ 9,100,000 $ 8,200,000

Average operating assets $ 1,020,000 $ 2,275,000 $ 1,640,000

Net operating income (19%) $ 193,800 $ 432,250 $ 311,600

Minimum required rate of return 17.00 % 32.80 % 14.00 %

3-a. If performance is being measured by ROI, Divisions A and C will accept the opportunity, while Division B will reject it because the actual rate of return of 19% is less than the minimum required rate of return of 32.8%.

3-b. Divisions A and C will accept the opportunity, while Division B will reject it.

Residual income (loss) = Operating Income - (Operating Assets x Target Rate of Return)

Division A = $20,400 ($193,800 - ($1,020,000 * 17%))

Division B = ($313,950) ($432,250 - ($2,275,000 * 32.8%))

Division C = $82,600 ($311,600 - ($1,640,000 * 14%))