NorthSouthEastWest Sales$100,000$25,000$75,000$76,000 CGS$50,000$5,000$50,674$45,000 other expenses$25,000$3,000$12,894$15,000 Average total assets$5,000,000$50,000$300,500$567,850 Using the information, calculate the operating profit percentage for each of the divisions. Comment on how your analysis has changed compared to your analysis of the dollar amounts for each division. Using total assets as the investment, calculate the ROI for each division. Comment on the results. Assume a cost of capital of 10%. Calculate the RI for each of the divisions. Comment on the results.

Solution: Operating profit is also known as recurring profit or earning before interest and tax. It a company's profit after deducting operating expenses, which are the expenses incurred during the daily course of business. Return on Investment (ROI) is commonly used as a divisional performance measure, it can lead to decisions that benefit the division but hurt the organization as a whole. These trends are mainly used to evaluate managers. Residual income is the dollar amount of division operating profit in excess of the division's cost of acquiring capital to purchase its operating assets. The percent cost of capital is new and represents the company's percentage cost to obtain investment funds. The goal is for each division manager to increase Residual Income (RI) over time.Analysis and Calculation: Operating profit (%) can be calculated using the following formula; Operating Profit (%) = Operating Profit or Net income / Net sales Return on Investment (ROI) can be calculated is as follows: ROI = Return or net income / Average total assets Residual Income (RI) = Operating Income - (Percent of Cost of Capital * Average operating assets) North South East West Sales $100,000 $25,000 $75,000 $76,000 CGS ($50,000) ($5,000) ($50,674) ($45,000) Gross Profit $50,000 $20,000 $24,326 $31,000 other expenses ($25,000) ($3,000) ($12,894) ($15,000) Operating Profit $25,000 $17,000 $11,432 $16,000 Average total assets $5,000,000 $50,000 $300,500 $567,850 Using the information, calculate the operating profit percentage for each of the divisions. 0.25 or 25% ($25,000/$100,000) 0.68 or 68% ($17,000/$25,000) 0.15 or 15% ($11,432/$75,000) 0.21 or 21% ($16,000/$76,000) Using total assets as the investment, calculate the ROI for each division. 0.005 or 0.5% ($25,000/$5,000,000) 0.34 or 34% ($17,000/$50,000) 0.038 or 3.8% ($11,432/$300,500) 0.028 or 2.8% ($16,000/$567,850) Assume a cost of capital of 10%. Calculate the RI for each of the divisions. Comment on the results. ($475,000) ($25,000 - [10% * $5,000,000]) $12,000 ($17,000 - [10% * $50,000]) ($18,618) ($11,432 - [10% * $300,500]) ($40,785) ($16,000 - [10% * $567,850]) A higher operating income margin indicates that the company is earning enough money from business operations to pay for all the associated costs. It tells you how well the company's operations contribute to its profitability. In the instant case, South division has higher operating income percentage (68%) than the other remaining divisions of East (15%), West (21%) and North (25%). If evaluated solely based on ROI, division manager would prefer to invest only in projects that increase the division's ROI above the required return on investment. Among all these projects, South are producing a return (34%) above the company's all remaining projects such as North (25%) , East (3.8%) and West (2.8%). An alternative measure is called as Residual Income, which helps to mitigate the apparent conflict. It is an effective way to minimize the conflict between company goals and division goals that arise using ROI. Using both measures has the benefit of comparing one division to another by using ROI and RI. It is also noticed that Company have only one positive RI (South), which indicates South divisions are producing operating income above and beyond the minimum required rate of return. And It is also reasonable that company has negative RI since Divisions of East, West and North's RI is less than 10%.

Answered: North South East West Sales…

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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	North	South	East	West
Sales	$100,000	$25,000	$75,000	$76,000
CGS	$50,000	$5,000	$50,674	$45,000
other expenses	$25,000	$3,000	$12,894	$15,000
Average total assets	$5,000,000	$50,000	$300,500	$567,850

Using the information, calculate the operating profit percentage for each of the divisions. Comment on how your analysis has changed compared to your analysis of the dollar amounts for each division.
Using total assets as the investment, calculate the ROI for each division. Comment on the results.
Assume a cost of capital of 10%. Calculate the RI for each of the divisions. Comment on the results.