Chapter 15, Problem 4ATC

a.

To determine

Ascertain the return on investment (ROI) for each of the geographical segments of Company CC for the years 2011 and 2010. Identify the segment that has performed well in 2011, based on the ROI, and also identify the segment that has improved from 2010 to 2011.

Explanation of Solution

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 of companies.

Formula of ROI:

$\text{Return on investment = }\frac{\text{Operating income}}{\text{Operating assets}}$

Ascertain the ROI of Segment EA for the years 2010 and 2011.

Particulars	2010 (in millions)	2011 (in millions)
Income before taxes (a)	$1,000	$1,089
Identifiable operating assets (b)	$1,278	$1,245
Return on Investment $\left(\frac{\text{a}}{\text{b}}\right)$	78.25%	87.47%

Table (1)

Ascertain the ROI of Segment E for the years 2010 and 2011.

Particulars	2010 (in millions)	2011 (in millions)
Income before taxes (a)	$3,020	$3,134
Identifiable operating assets (b)	$2,724	$3,204
Return on Investment $\left(\frac{\text{a}}{\text{b}}\right)$	110.87%	97.82%

Table (2)

Ascertain the ROI of Segment LA for the years 2010 and 2011.

Particulars	2010 (in millions)	2011 (in millions)
Income before taxes (a)	$2,426	$2,832
Identifiable operating assets (b)	$2,298	$2,446
Return on Investment $\left(\frac{\text{a}}{\text{b}}\right)$	105.57%	115.78%

Table (3)

Ascertain the ROI of Segment NA for the years 2010 and 2011.

Particulars	2010 (in millions)	2011 (in millions)
Income before taxes (a)	$1,523	$2,325
Identifiable operating assets (b)	$32,793	$33,422
Return on Investment $\left(\frac{\text{a}}{\text{b}}\right)$	4.64%	6.96%

Table (4)

Ascertain the ROI of Segment P for the years 2010 and 2011.

Particulars	2010 (in millions)	2011 (in millions)
Income before taxes (a)	$2,049	$2,154
Identifiable operating assets (b)	$1,827	$2,085
Return on Investment $\left(\frac{\text{a}}{\text{b}}\right)$	112.15%	103.31%

Table (5)

Analysis: Of all segments, Segment LA has performed well in 2011, with the highest ROI of 115.78%. The ROI of Segment LA has improved from 2010 to 2011.

b.

To determine

Ascertain the residual income for each of the geographical segments of Company CC for the years 2011 and 2010. Identify the segment that has performed well in 2011, based on the residual income, and also identify the segment that has improved from 2010 to 2011.

Explanation of Solution

Residual income: Residual income is the excess of income over the minimum acceptable return on average capital invested. The minimum rate of return shows the opportunity cost of using the invested capital. The formula for residual income is as follows:

$\text{Residual income = Operating earnings}-\left\{\left(\begin{array}{l}\text{Minimum }\\ \text{acceptable }\\ \text{return}\end{array}\right)\times \text{Invested capital}\right\}$

Ascertain the residual income for each of the geographical segments of Company CC for the years 2010 (amount in millions).

Residual income for 2010
Particulars	Geographical Segments
	EA	E	LA	NA	P
Income before taxes (A)	$1,000	$3,020	$2,426	$1,523	$2,049
Identifiable operating assets (B)	$1,278	$2,724	$2,298	$32,793	$1,827
Minimum rate of return at 30%	30%	30%	30%	30%	30%
Residual income for 2010 $\left[\left(\text{C}\right)=\left(\text{A}\right)-\left(\left(\text{B}\right)\times 30\%\right)\right]$	$617	$2,203	$1,737	($8,315)	$1,501

Table (6)

Ascertain the residual income for each of the geographical segments of Company CC for the years 2011 (amount in millions).

Residual income for 2011
Particulars	Geographical Segments
	EA	E	LA	NA	P
Income before taxes (A)	$1,089	$3,134	$2,832	$2,325	$2,154
Identifiable operating assets (B)	$1,245	$3,204	$2,446	$33,422	$2,085
Minimum rate of return at 30%	30%	30%	30%	30%	30%
Residual income for 2010 $\left[\left(\text{C}\right)=\left(\text{A}\right)-\left(\left(\text{B}\right)\times 30\%\right)\right]$	$716	$2,173	$2,098	($7,702)	$1,529

Table (7)

Analysis: Of all segments, Segment E has performed well in 2011, with the highest residual income of $2,173 million, and in 2010, with highest residual income of $2,203 million. On the basis of residual income, Segment LA has improved the most from 2010 to 2011 with an increase of $361 million $\left(\$2,098-\$1,737\right)$ .

c.

To determine

Explain the reason for the segment with highest ROI in 2011 but was not the segment with highest residual income.

Explanation of Solution

Of all segments, Segment LA had the highest ROI of 115.78% in 2011, but it was not the segment with highest residual income.

Reason: Residual income depends on the value of operating assets. Since Segment E had more operating assets than Segment LA, the residual income of Segment LA was lower in 2011, despite of highest ROI.

d.

To determine

Indicate the segment that stands as the best investment opportunity for Company CC, and give reasons.

Explanation of Solution

Best investment opportunity: Segment LA would be the best segment for the investment opportunity for Company CC, based on the ROI. Company CC should consider the non-quantitative factors too, before investing in Segment LA.