Chapter 10 Homework

Juniper Design Limited of Manchester, England, is a company specializing in providing design services to residential developers. Last year the company had net operating income of $600,000 on sales of $3,000,000. The company's average operating assets for the year were $2,800,000 and its minimum required rate of return was 18%. Required: Compute the company's residual income for the year.

Residual income= $96,000 Explanation Average operating assets$ 2,800,000 Net operating income$ 600,000 Minimum required return: 18% × $2,800,000 = 504,000 Residual income$ 96,000

Selected sales and operating data for three divisions of different structural engineering firms are given as follows: Division ADivision BDivision CSales$ 12,000,000$ 14,000,000$ 25,000,000Average operating assets$ 3,000,000$ 7,000,000$ 5,000,000Net operating income$ 600,000$ 560,000$ 800,000Minimum required rate of return14%10%16% 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 15% 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?

1. Division (A) Margin: 5.0% Turnover: 4.0 ROI: 20.0% Divison (B) Margin: 4.0% Turnover: 2.0 ROI: 8.0% Divison (C) Margin: 3.2% Turnover: 5.0 ROI: 16.0% 2. Residual income (loss) (A) $180,000 (B) $(140,000) (C)$0 3A.Division (A) Reject Division (B)Accept Division (C)Reject 3B. Division (A)Accept Division (B)Accept Division (C) Reject Explanation: 1. ROI computations:ROI = (Net operating income/Sales) × (Sales/Average operating assets)Division A:ROI = ($600,000/$12,000,000) × ($12,000,000/$3,000,000) = 5.0% × 4.0 = 20.0%Division B:ROI = ($560,000/$14,000,000) × ($14,000,000/$7,000,000) = 4.0% × 2.0 = 8.0%Division C:ROI = ($800,000/$25,000,000) × ($25,000,000/$5,000,000) = 3.2% × 5.0 = 16.0%2. Division ADivision BDivision CAverage operating assets$ 3,000,000$ 7,000,000$ 5,000,000Required rate of return× 14%× 10%× 16%Minimum required return$ 420,000$ 700,000$ 800,000Actual operating income$ 600,000$ 560,000$ 800,000Minimum required return (above)420,000700,000800,000Residual income$ 180,000$ (140,000)$ 0 3. a. & b. Division ADivision BDivision CReturn on investment (ROI)20%8%16%Therefore, if the division is presented with an investment opportunity yielding 15%, it probably wouldRejectAcceptRejectMinimum required return for computing residual income14%10%16%Therefore, if the division is presented with an investment opportunity yielding 15%, it probably wouldAcceptAcceptReject If performance is being measured by ROI, both Division A and Division C probably would reject the 15% investment opportunity. These divisions' ROIs currently exceed 15%; accepting a new investment with a 15% rate of return would reduce their overall ROIs. Division B probably would accept the 15% investment opportunity because accepting it would increase the division's overall rate of return.If performance is measured by residual income, both Division A and Division B probably would accept the 15% investment opportunity. The 15% rate of return promised by the new investment is greater than their required rates of return of 14% and 10%, respectively, and would therefore add to the total amount of their residual income. Division C would reject the opportunity because the 15% return on the new investment is less than its 16% required rate of return.

Alyeska Services Company, a division of a major oil company, provides various services to the operators of the North Slope oil field in Alaska. Data concerning the most recent year appear below: Sales $ 7,500,000 Net operating income $ 600,000 Average operating assets$ 5,000,000 Required: 1. Compute the margin for Alyeska Services Company. 2. Compute the turnover for Alyeska Services Company. (Round your answer to 1 decimal place.) 3. Compute the return on investment (ROI) for Alyeska Services Company. (Do not round intermediate calculations.)

Explanation 1.Margin = Net operating income/Sales = $600,000/$7,500,000 = 8% 2.Turnover = Sales/Average operating assets = $7,500,000/$5,000,000 = 1.5 3.ROI = Margin × Turnover = 8% × 1.5 = 12%

Provide the missing data in the following table for a distributor of martial arts products: (Round Bravo's Turnover to 1 decimal place.) Alpha division, Bravo Division, and Charlie Division

Sales$4,000,000; $11,500,000; $3,000,000 Net operating income$160,000; $920,000; $210,000 Average operating assets$800,000; $4,600,000; $1,500,000 Margin4%;8%;7%; Turnover 5; 2.5; 2 Return on investment (ROI) 20%; 20%; 14% Explanation: Note that Divisions Alpha and Bravo apparently have different strategies to obtain the same 20% return. Division Alpha has a low margin and a high turnover, whereas Division Bravo has just the opposite.

Revise the data in your worksheet as follows: If your formulas are correct, you should get the correct answers to the following questions. a. What is the ROI? b. What is the residual income? c. why is the residual income positive?

a. 30% b. 40,000 c. The ROI exceeds the minimum rate of return Explanation: 2. The numbers in your worksheet should match those in the worksheet shown below. If they do, you are ready to proceed to the next question. If they do not, go to step 1 below. Step 1Do the numbers in the Data area of your worksheet match the numbers in the table below? If they do, proceed to Step 2. If they do not, enter the correct amounts in your worksheet. Do you get the correct numbers now throughout the worksheet? If not, go to Step 2 below. Step 2If a number in your worksheet does not match the number in the worksheet below, one or more of your formulas is probably wrong. Correct the formulas and then check to make sure that all of the numbers in your worksheet match the numbers in the worksheet below. If they do, you are ready to proceed to the next question. a. The ROI is 30% b. The residual income is $40,000 c. When the ROI exceeds the minimum required rate of return, the residual income is positive. When the ROI equals the minimum required rate of return, the residual income is zero. When the ROI is less than the minimum required rate of return, the residual income is negative.