Selected operating data for two divisions of Outback Brewing, Ltd., of Australia are given below:

Selected operating data for two divisions of Outback Brewing, Ltd., of Australia are given below:

	Division
	Queensland		New South Wales
Sales	$	936,000	$	1,972,000
Average operating assets	$	520,000	$	580,000
Net operating income	$	98,280	$	147,900
Property, plant, and equipment (net)	$	249,000	$	199,000

Required:

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

2. Which divisional manager seems to be doing the better job?

Explanation

1.

ROI computations:

ROI =	Net operating income	×	Sales
	Sales		Average operating assets

Queensland Division:

ROI =	$98,280	×	$936,000	= 10.5% × 1.8 = 18.90%
	$936,000		$520,000

New South Wales Division:

ROI =	$147,900	×	$1,972,000	= 7.5% × 3.4 = 25.50%
	$1,972,000		$580,000

2.

The manager of the New South Wales Division seems to be doing the better job. Although the New South Wales Division’s margin is 3 percentage points lower than the margin of the Queensland Division, its turnover is higher (a turnover of 3.4, as compared to a turnover of 1.8 for the Queensland Division). The greater turnover more than offsets the lower margin, resulting in a 25.5% ROI, as compared to an 18.9% ROI for the other division.

Notice that if you look at margin alone, then the Queensland Division appears to be the stronger division. This fact underscores the importance of looking at turnover as well as at margin in evaluating performance in an investment center.

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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.

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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:

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	$	18,500,000
Net operating income	$	5,800,000
Average operating assets	$	35,100,000

Required:

1. Compute the margin for Alyeska Services Company. (Round your answer to 2 decimal places.)

2. Compute the turnover for Alyeska Services Company. (Round your answer to 2 decimal places.)

3. Compute the return on investment (ROI) for Alyeska Services Company. (Round your intermediate calculations and final answer to 2 decimal places.)

Explanation

1.

Margin	=	Net operating income
		Sales
	=	$5,800,000	= 31.35%
		$18,500,000

2.

Turnover	=	Sales
		Average operating assets
	=	$18,500,000	= 0.53
		$35,100,000

3.

ROI	= Margin × Turnover
	= 31.35% × 0.53 = 16.62%

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Fitness Fanatics is a regional chain of health clubs. The managers of the clubs, who have authority to make investments as needed, are evaluated based largely on return on investment (ROI).

Fitness Fanatics is a regional chain of health clubs. The managers of the clubs, who have authority to make investments as needed, are evaluated based largely on return on investment (ROI). The company's Springfield Club reported the following results for the past year:

Sales	$	910,000
Net operating income	$	32,760
Average operating assets	$	100,000

The following questions are to be considered independently.

Required:

1. Compute the Springfield club’s return on investment (ROI).

Explanation

1.

Margin	=	Net operating income
		Sales
	=	$32,760	= 3.60%
		$910,000

Turnover	=	Sales
		Average operating assets
	=	$910,000	= 9.10
		$100,000

ROI	=	Margin × Turnover
	=	3.60% × 9.10 = 32.76%

2. Assume that the manager of the club is able to increase sales by $91,000 and that, as a result, net operating income increases by $8,281. Further assume that this is possible without any increase in average operating assets. What would be the club’s return on investment (ROI)? 

Explanation

2.

Margin	=	Net operating income
		Sales
	=	$32,760 + $8,281
		$910,000 + $91,000
	=	$41,041	= 4.10%
		$1,001,000

Turnover	=	Sales
		Average operating assets
	=	$910,000 + $91,000
		$100,000
	=	$1,001,000	= 10.01
		$100,000

ROI	=	Margin × Turnover
	=	4.10% × 10.01 = 41.04%

3. Assume that the manager of the club is able to reduce expenses by $3,640 without any change in sales or average operating assets. What would be the club’s return on investment (ROI)? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Explanation

3.

Margin	=	Net operating income
		Sales
	=	$32,760 + $3,640
		$910,000
	=	$36,400	= 4.00%
		$910,000

Turnover	=	Sales
		Average operating assets
	=	$910,000	= 9.10
		$100,000

ROI	=	Margin × Turnover
	=	4.00% × 9.10 = 36.40%

4. Assume that the manager of the club is able to reduce average operating assets by $30,000 without any change in sales or net operating income. What would be the club’s return on investment (ROI)? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
 

Explanation

4.

Margin	=	Net operating income
		Sales
	=	$32,760	= 3.60%
		$910,000

Turnover	=	Sales
		Average operating assets
	=	$910,000
		$100,000 − $30,000
	=	$910,000	= 13.00
		$70,000

ROI	=	Margin × Turnover
	=	3.60% × 13.00 = 46.80%

 

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