Selected sales and operating data for three divisions of different structural engineering firms are given as follows: Division A Division B Division C Sales $ 12,000,000 $ 14,000,000 $ 25,000,000 Average operating assets $ 3,000,000 $ 7,000,000 $ 5,000,000 Net operating income $ 600,000 $ 560,000 $ 800,000 Minimum required rate of return 14% 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

1. See part 1 below for the calculations.

2. We have:

Division A's Residual Income (loss) = $180,000

Division B's Residual Income (loss) = ($140,000)

Division C's Residual Income (loss) = $0

3.a. Only Division B will probably accept the investment opportunity.

3.b. Divisions A and B will probably accept the investment opportunity.

Explanation:

Note: This question is not complete as the part 3-b of the requirement is omitted. The question is therefore completed before answering the question by providing the part 3-b as follows:

b. If performance is being measured by residual income, which division or divisions will probably accept the opportunity?

The explanation of the answer is now provided as follows:

The following are given:

                                              Division A        Division B           Division C

Sales                                     $12,000,000     $14,000,000     $25,000,000

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

Net operating income             $600,000          $560,000            $800,000

Min. req'd rate of return               14%                      10%                      16%

1. Compute the return on investment (ROI) for each division using the formula stated in terms of margin and turnover.

The relevant formulae are as follows:

Margin = Net Operating Income / Sales

Turnover = Sales / Average Operating Assets

Return on Investment = Margin * Turnover

Therefore, we have:

Division A:

Margin = $600,000 / $12,000,000 = 0.05, or 5%

Turnover = $12,000,000 / $3,000,000 = 4 times

Return on Investment = 5% * 4 = 0.20, or 20%

Division B:

Margin = $560,000 / $14,000,000 = 0.04, or 4%

Turnover = $14,000,000 / $7,000,000 = 2 times

Return on Investment = 4% * 2 = 0.08, or 8%

Division C:

Margin = $800,000 / $25,000,000 = 0.032, or 3.20%

Turnover = $25,000,000 / $ 5,000,000 = 5 times

Return on Investment = 3.2% * 5 = 0.16, or 16%

2. Compute the residual income (loss) for each division.

The following is the formula to use:

Residual Income (loss) = Net Operating Income - (Minimum Required Return * Average Operating Assets)

Therefore, we have:

Division A's Residual Income (loss) = $600,000 - (14% * $3,000,000) = $180,000

Division B's Residual Income (loss) = $560,000 - (10% * $7,000,000) = ($140,000)

Division C's Residual Income (loss) = $800,000 - (16% * $5,000,000) = $0

3-a. Assume that each division is presented with an investment opportunity that would yield a 15% rate of return. If performance is being measured by ROI, which division or divisions will probably accept the opportunity?

If a division's Return on Investment (ROI) is less than 15%, the decision criterion is to accept the investment opportunity. Otherwise, it will be rejected. Therefore, only Division B is will probably accept the investment opportunity, based on the results of Part 1 above. Division A and C will reject it.

3-b. Assume that each division is presented with an investment opportunity that would yield a 15% rate of return. If performance is being measured by residual income, which division or divisions will probably accept the opportunity?

The decision criterion is for a division to accept the investment opportunity if its minimum required rate of return is lower than 15%. Otherwise, it will be rejected.

Based on the information in the question, Divisions A and B will probably accept the investment opportunity. Division C will reject it.

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