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202E11

# Ri net operating income charge for use of capital ri

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RI = Net operating income - Charge for use of capital RI = Net operating income - (Average operating assets X Minimum required rate of return) Division A Division B Division C Net operating income \$300,000 \$900,000 \$180,000 Charge for use of capital (\$225,000) (\$900,000) (\$240,000) Residual income \$75,000 \$0 (\$60,000) 3. Assume that each division is presented with an investment opportunity that would yield a rate of return of 17%. a. If performance is being measured by ROI, which division or divisions will probably accept the opportunity? Reject? Why? Division A Division B Division C Current ROI 20% 18% 9% Investment opportunity return 17% 17% 17% Effect on ROI if opportunity is accepted Decrease Decrease Increase Accept or reject decision Reject Reject Accept b. If performance is being measured by RI, which division or divisions will probably accept the opportunity? Reject? Why? Division A Division B Division C Current RI \$75,000 \$0 (\$60,000) Investment opportunity return 17% 17% 17% Minimum required rate of return 15% 18% 12% Effect on RI if opportunity is accepted Increase Decrease Increase Accept or reject decision Accept Reject Accept

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Exercise 11-12 Effects of Changes in Profits and Assets on Return on Investment Given: The Abs Shoppe is a regional chain of health clubs. The managers of the clubs, who have authority to make investments as needed, are evaluated based largely on ROI. The Abs Shoppe reported the following results for the past year: Abs Shoppe Sales \$800,000 Net operating income \$16,000 Average operating assets \$100,000 Required: The following questions are to be considered independently. Carry out all computations to two decimal places. 1. Compute the club's ROI a. ROI = Net operating income / Average operating assets b. ROI = margin X turnover ROI = (Net operating income / Sales) X (Sales / Average operating assets) Abs Shoppe Margin 2.00% Turnover 8.00 b. ROI 16.00% a. ROI 16.00% 2. increase in operating assets. What would be the club's ROI? Original Changes New Sales \$800,000 \$80,000 \$880,000 Net operating income \$16,000 \$6,000 \$22,000 Average operating assets \$100,000 \$0 \$100,000 Abs Abs Shoppe Shoppe Margin 2.00% 2.50% Turnover 8.00 8.80 ROI 16.00% 22.00% ROI 16.00% 22.00% 3. change in sales or operating assets. What would be the club's ROI? Original Changes New Sales \$800,000 \$0 \$800,000 Net operating income \$16,000 \$3,200 \$19,200 Average operating assets \$100,000 \$0 \$100,000 Abs Abs Shoppe Shoppe Margin 2.00% 2.40% Turnover 8.00 8.00 ROI 16.00% 19.20% ROI 16.00% 19.20% 4. change in sales or net operating income. What would be the club's ROI? Original Changes New Sales \$800,000 \$0 \$800,000 Net operating income \$16,000 \$0 \$16,000 Average operating assets \$100,000 (\$20,000) \$80,000 Abs Abs Shoppe Shoppe Margin 2.00% 2.00% Turnover 8.00 10.00 ROI 16.00% 20.00% ROI 16.00% 20.00% Assume that the manager of the club is able to increase sales by \$80,000 and that as a result net operating income increases by \$6,000 . Further assume that this is possible without any
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RI Net operating income Charge for use of capital RI Net...

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