Comparing return on investment and residual income
Angelo Corporation operates three investment centers. The following financial statements apply to the investment center named Owen Division.
Income Statement For the Year Ended December 31, 2008 |
|
Sales revenue |
$113,385 |
Cost of goods sold |
(60,420) |
Gross margin |
52,965 |
Operating expenses |
|
Selling expenses |
(1,345) |
Depreciation expense |
(1,300) |
Operating income |
52,320 |
Nonoperating income |
|
Gain on sale of land |
4,460 |
Net income |
$ 54,780 |
OWEN DIVISION |
|
Assets |
|
Cash |
$18,303 |
Accounts receivable |
37,032 |
Merchandise inventory |
37,455 |
Equipment less accum. dep. |
90,000 |
Non operating assets |
10,000 |
Total assets |
$192,790 |
Liabilities |
|
Accounts payable |
$6,700 |
Notes payable |
67,310 |
Stockholders’ equity |
|
Common stock |
64,000 |
Retained earnings |
54,780 |
Total liab. and stk. equity |
$192,790 |
Required
a. Should operating income or net income be used to determine the rate of return (ROI) for the Owen investment center? Explain your answer.
b. Should operating assets or total assets be used to determine the ROI for the Owen investment center? Explain your answer.
c. Calculate the ROI for Owen.
d. Angelo has a desired ROI of 10 percent. Headquarters has $91,000 of funds to assign its investment centers. The manager of the Owen division has an opportunity to invest the funds at an ROI of 13 percent. The other two divisions have investment opportunities that yield only 12 percent. Even so, the manager of Owen rejects the additional funding. Explain why the manager of Owen would reject the funds under these circumstances.
e. Explain how residual income could be used to encourage the manager to accept the additional funds.