Question 2.
The Central Division of Miller's Quarter Horse Company has sales of $4,500,000. It also has invested assets of $2,500,000 and operating expenses of $3,800,000. The company has established a minimum rate of return of 7%.
Required:
Determine the following for the Central Division:
Profit Margin
ROI using DuPont formula
Residual Income
Miller has offered a new investment opportunity to the Central Division, which has a Return of Investment of 20% calculated as an operating income of $160,000 divided by the invested asset of $800,000.
Explain by undertaking required calculation, whether the manager of the Central division would undertake the additional investment opportunity if:
He was paid a bonus based upon his division’s overall ROI.
He was paid a bonus based upon his division’s overall RI
Solution:
Intermediate working/formula
Income from operations
Sales – Expense
Profit margin
Income from operation /Sales
Investment Turnover
Sales / Invested Assets
ROI using Du Pont formula
Profit Margin x Investment Turnover
Minimum Acceptable Income
Invested Assets x Minimum Desired ROI
Residual Income
Income from Operation – Minimum Acceptable Income
Central Division
Before accepting the new investment:
ROI:
RI:
After accepting the new investment
ROI:
RI: