Concept explainers
Determining missing items from computations
Data for the North, South, East, and West divisions of Free Bird Company are as follows:
- A. Determine the missing items, identifying each by the letters (A) through (L). (Round percentages and investment turnover to one decimal place.)
- B. Determine the residual income for each division, assuming that the minimum acceptable
return on investment established by management is 12%. - C. Which division is the most profitable in terms of (1) return on investment and (2) residual income?
(a)
Profit margin: This ratio gauges the operating profitability by quantifying the amount of income earned from business operations from the sales generated.
Formula of profit margin:
Investment turnover: This ratio gauges the operating efficiency by quantifying the amount of sales generated from the assets invested.
Formula of investment turnover:
Return on investment (ROI): This financial ratio evaluates how efficiently the assets are used in earning income from operations. So, ROI is a tool used to measure and compare the performance of a units or divisions or a companies.
Formula of ROI according to Dupont formula:
Residual income: The remaining income from operations after deducting the desired acceptable income is referred to as residual income.
Formula of residual income:
Income from operations | XXX |
Less minimum acceptable income from operations as a percent of invested assets | XXX |
Residual income | XXX |
Table (1)
To compute: The missing items
Explanation of Solution
1)
Compute income from operations.
2)
Compute invested assets.
Note: Refer to missing amount (a) for value of income from operations.
3)
Compute investment turnover.
4)
Compute sales value.
5)
Compute sales value.
Note: Refer to missing amount (d) for value of sales.
6)
Compute ROI.
Note: Refer to missing amount (e) for value of invested assets.
7)
Compute income from operations.
8)
Compute profit margin.
Note: Refer to missing amount (g) for value of income from operations.
9)
Compute investment turnover.
10)
Compute ROI.
11)
Compute profit margin.
12)
Compute investment turnover.
(b)
Explanation of Solution
1)
Determine residual income of N Division.
Step 1: Compute minimum acceptable income from operations as a percent of invested assets for N Division.
Note: Refer to missing amount (b) of part (a) for value of invested assets.
Step 2: Determine residual income of N Division.
Particulars | Amount ($) |
Income from operations | $60,200 |
Less minimum acceptable income from operations as a percent of invested assets | 41,280 |
Residual income | $18,920 |
Table (2)
Note: Refer to missing amount (a) of part (a) for value of income from operations, and Step 1 for value and computation of minimum acceptable income.
2)
Determine residual income of S Division.
Step 1: Compute minimum acceptable income from operations as a percent of invested assets for S Division.
Note: Refer to missing amount (e) of part (a) for value of invested assets.
Step 2: Determine residual income of S Division.
Particulars | Amount ($) |
Income from operations | $51,300 |
Less minimum acceptable income from operations as a percent of invested assets | 36,000 |
Residual income | $15,300 |
Table (3)
Note: Refer to Step 1 for value and computation of minimum acceptable income.
3)
Determine residual income of E Division.
Step 1: Compute minimum acceptable income from operations as a percent of invested assets for E Division.
Step 2: Determine residual income of E Division.
Particulars | Amount ($) |
Income from operations | $102,000 |
Less minimum acceptable income from operations as a percent of invested assets | 81,600 |
Residual income | $20,400 |
Table (4)
Note: Refer to missing amount (g) of part (a) for value of income from operations, and Step 1 for value and computation of minimum acceptable income.
4)
Determine residual income of W Division.
Step 1: Compute minimum acceptable income from operations as a percent of invested assets for W Division.
Step 2: Determine residual income of W Division.
Particulars | Amount ($) |
Income from operations | $89,600 |
Less minimum acceptable income from operations as a percent of invested assets | 67,200 |
Residual income | $22,400 |
Table (5)
Note: Refer to missing amount (g) of part (a) for value of income from operations, and Step 1 for value and computation of minimum acceptable income.
(c) 1
Explanation of Solution
The division with highest return on investment is considered as the most profitable division. Hence, N Division is the most profitable division with highest ROI of 17.5%.
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Chapter 23 Solutions
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