Question

Sports Company makes snowboards, downhill skis, cross-country skies, skateboards, surfboards, and in-line skates. The company found it beneficial to split operations into two divisions based on the climate required for the sport: Snow Sports and Non-Snow Sports. The following divisional information is available for the past year:

Sales Operating Income Total Assets Crrent Liabilities ROI
Snow Sports 5,800,000 $ $ 990,000 4,400,000 500,000 22.5%
Non-Snow $ 8,800,000 $ 1,512,000 $ $ 6,300,000$ 750,000 24.0%
Sports
Tests management has specified a target 15% rate of return.
Compute each division's residual income. Interpret your results. Are your results consistent with each division's ROI?

Answer 1

I. Residual Income:

Snow division

Residual Income = Operating income - (Total assets × Target rate of return)

Residual Income = $990,000 - ($4,400,000 * 15%)

Residual Income = $330,000

Thus, The residual income of the snow division is $330,000.

Non-snow division

Residual Income = Operating income - (Total assets × Target rate of return)

Residual Income = $1,512,000 - ($6,300,000 * 15%)

Residual Income = $567,000

Thus, The residual income of the non-snow division is $567,000

ii. The divisions have positive residual incomes, that is, both the divisions are earning income more than the target return on the investments.

iii. The results are consistent with the return on investment calculations of both the divisions.