Chapter 15, Problem 23P

Problem 9-21A Comparing return on investment and residual income

Helena Corporation operates three investment centers. The following financial statements apply to the investment center named Bowman Division:

BOWMAN DIVISION Income Statement For the Year Ended December 31, 2018
Sales revenue	$138,000
Cost of goods sold	78,000
Gross margin	60,000
Operating expenses
Selling expenses	(6,000)
Depreciation expense	(8,000)
Operating income	46,000
Nonoperating item
Loss on sale of land	(16,000)
Net income	$ 30,000

BOWMAN DIVISION Balance Sheet As of December 31, 2018
Assets
Cash	$ 18,898
Accounts receivable	42,266
Merchandise inventory	37,578
Equipment less accum. dep.	90,258
Nonoperating assets	9,000
Total assets	$198,000
Liabilities
Accounts payable	$ 9,637
Notes payable	72,000
Stockholders’ equity
Common stock	80,000
Retained earnings	36,363
Total liab. and stk. equity	$198,000

Required

1. a. Which should be used to determine the rate of return (ROI) for the Bowman investment center, operating income or net income? Explain your answer.
2. b. Which should be used to determine the ROI for the Bowman investment center, operating assets or total assets? Explain your answer.
3. c. Calculate the ROI for Bowman. Round the computation to two decimal points.
4. d. Cole has a desired ROI of 10 percent. Headquarters has $96,000 of funds to assign to its investment centers. The manager of the Bowman Division has an opportunity to invest the funds at an ROI of 12 percent. The other two divisions have investment opportunities that yield only 11 percent. Even so, the manager of Bowman rejects the additional funding. Explain why the manager of Bowman would reject the funds under these circumstances. Round the computation to two decimal points.
5. e. Explain how residual income could be used to encourage the manager to accept the additional funds. Round the computation to whole dollars.