Chapter 9, Problem 1ATC

a.

To determine

Ascertain the return on investment (ROI) for each of the geographical segments of Company CC for the years 2011 and 2010, indicate the segment that has performed well in 2014, based on the ROI, and indicate 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	2011
Income before taxes	$1,000,000,000	$1,089,000,000
Identifiable operating assets	÷ 1,278,000,000	÷ 1,245,000,000
ROI	78.25%	87.47%

Table (1)

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

Particulars	2010	2011
Income before taxes	$3,020,000,000	$3,134,000,000
Identifiable operating assets	÷ 2,724,000,000	÷ 3,204,000,000
ROI	110.87%	97.82%

Table (2)

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

Particulars	2010	2011
Income before taxes	$2,426,000,000	$2,832,000,000
Identifiable operating assets	÷ 2,298,000,000	÷ 2,446,000,000
ROI	105.57%	115.78%

Table (3)

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

Particulars	2010	2011
Income before taxes	$1,523,000,000	$2,325,000,000
Identifiable operating assets	÷ 32,793,000,000	÷ 33,422,000,000
ROI	4.64%	6.96%

Table (4)

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

Particulars	2010	2011
Income before taxes	$2,049,000,000	$2,154,000,000
Identifiable operating assets	÷ 1,827,000,000	÷ 2,085,000,000
ROI	112.51%	103.31%

Table (5)

Analysis: Of all segments, Segment LA has performed well in 2011, with the highest ROI of 115.78%. Segments EA, LA, and NA have improved from 2010 to 2011, but Segment LA improved the most.

b.

To determine

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

Explanation of Solution

Residual income: The excess of income from operations over the desired acceptable income is referred to as residual income.

Formula of residual income:

$\text{Residual income = Operating income – }\left(\begin{array}{l}\text{Operating assets}\times \\ \text{Desired rate of return on investment}\end{array}\right)$

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

Segment	Income Before Taxes	˗	$Operatingassets\times DesiredROI$	=	Residual Income
EA	$1,089	˗	$\$1,245\times 30\%=\$373.5$	=	$716
E	3,134	˗	$3,204\times 30\%=\$961.2$	=	2,173
LA	2,832	˗	$2,446\times 30\%=\$733.8$	=	2,098
NA	2,325	˗	$33,422\times 30\%=\$10,026.6$	=	(7,702)
P	2,154	˗	$2,085\times 30\%=\$625.5$	=	1,529

Table (6)

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

Segment	Income Before Taxes	˗	$Operatingassets\times DesiredROI$	=	Residual Income
EA	$1,000	˗	$\$1,278\times 30\%=\$383.4$	=	$617
E	3,020	˗	$2,724\times 30\%=\$817.2$	=	2,203
LA	2,426	˗	$2,298\times 30\%=\$689.4$	=	1,737
NA	1,523	˗	$32,793\times 30\%=\$9,837.9$	=	(8,315)
P	2,049	˗	$1,827\times 30\%=\$548.1$	=	1,501

Table (7)

Analysis: Of all segments, Segment E has performed well in 2011, with the highest residual income of $2,173 million, and performed well in 2010 as well, with highest residual income of $2,203 million. Segments EA, LA, and P have improved from 2010 to 2011, but Segment LA has improved the most.

c.

To determine

Explain the reason for the segment with highest ROI in 2010, was not the segment with highest residual income.

Explanation of Solution

Reason: Residual income depends on the operating assets value. Since Segment LA had more operating assets, the residual income was lower in 2010, despite 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.