Meiji Isetan Corp. of Japan has two regional divisions with headquarters in Osaka and Yokohama. Selected data on the two divisions follow:

Meiji Isetan Corp. of Japan has two regional divisions with headquarters in Osaka and Yokohama. Selected data on the two divisions follow:

	Division
	Osaka		Yokohama
Sales	$	9,600,000	$	26,000,000
Net operating income	$	672,000	$	2,340,000
Average operating assets	$	3,200,000	$	13,000,000

Required:

1. For each division, compute the return on investment (ROI) in terms of margin and turnover.

2. Assume that the company evaluates performance using residual income and that the minimum required rate of return for any division is 16%. Compute the residual income for each division.

3. Is Yokohama’s greater amount of residual income an indication that it is better managed?

Explanation

1.

ROI computations:

ROI =	Net operating income	×	Sales
	Sales		Average operating assets

Osaka Division:

ROI =	$672,000	×	$9,600,000	= 7% × 3 = 21%
	$9,600,000		$3,200,000

Yokohama Division:

ROI =	$2,340,000	×	$26,000,000	= 9% × 2 = 18%
	$26,000,000		$13,000,000

2.

	Osaka			Yokohama
Average operating assets (a)	$	3,200,000		$	13,000,000
Net operating income	$	672,000		$	2,340,000
Minimum required return on average operating assets: 16% × (a)		512,000			2,080,000
Residual income	$	160,000		$	260,000

3.

No, the Yokohama Division is simply larger than the Osaka Division and for this reason one would expect that it would have a greater amount of residual income. Residual income can’t be used to compare the performance of divisions of different sizes. Larger divisions will almost always look better. In fact, in the case above, the Yokohama Division does not appear to be as well managed as the Osaka Division. Note from Part (1) that Yokohama has only an 18% ROI as compared to 21% for Osaka.

Thanks