Question

Luke Company has three divisions: Peak, View, and Grand. The company has a hurdle rate of 5.01 percent. Selected operating data for the three divisions follow: Peak View Grand Sales revenue$332,000$233,000$311,000 Cost of goods sold 204,000 116,000 183,000 Miscellaneous operating expenses 36,000 30,000 33,000 Average invested assets 1,310,000 920,000 1,105,000 Required: 1. Compute the return on investment for each division. 2. Compute the residual income for each division.

Answer 1

Answer and Explanation:

The computation is shown below:

1. The return on investment is

As we know that

Return on Investment = Net operating profit ÷ average invested assets × 100

But before that the Net Operating Profit should be determined

Particulars Peak View Grand

Sales revenue $332,000 $233,000 $311,000

Less: Cost of

goods sold ($204,000) ($116,000) ($183,000)

Miscellaneous

operating Expenses ($36,000) ($30,000) ($33,000)

Net Profit $92,000 $87,000 $95,000

Now

Return on Investment is

For peak, it is

= $92,000 ÷ $1,310,000

= 7.02%

for view, it is

= $87,000 ÷ $920,000

= 9.46%

for grand, it is

= $95,000 ÷ $1,105,000

= 8.60%

2. The residual income is

We know that

Residual Income = Net operating income - (Minimum required rate of return × average invested assets)

For Peak, it is

= ($92,000 - (5.01% of $1,310,000)

= $26,369

For view, it is

= ($87,000 - (5.01% of $920,000)

= $40,908

And, for grand, it is

= ($95,000 - (5.01% of $1,105,000)

= $39,640