Wescott Company has three divisions: A, B, and C. The company has a hurdle rate of 8%. Selected operating data for the three divisions are as follows:

Division A Division B Division C

Sales Revenue $1,255,000 $920,000 $898,000

Cost of Goods Sold 776,000 675,000 652,000

Miscellaneous Operating Expenses 64,000 52,000 53,100

Interest and Taxes 48,000 41,000 41,500

Average Invested Assets 8,300,000 1,930,000 3,215,000

SOLUTION:

1.) Compute ROI for each division:

Division A

ROI = $415,000 / $8,300,000 = 5%

Division B

ROI = $193,000 / $1,930,000 = 10%

Division C

ROI = $192,900 / $3,21,000 = 6%

2.) Compute the Residual Income for each division:

Division A

RI Division A = $415,000 - ($8,300,000 X 8%) = $(249,000)

Division B

RI Division B = $93,000 - ($1,90,000 X 8%) = $38,600

Division C

RI Division C = $192,900 - ($3,215,000 X 8%) = $(64,300)

3.) Rank the divisions according to the ROI and residual income of each (best to worst):

Division B, Division C, Division A

4.) Compute the Return on Investment on the proposed expansion project:

Compute the return on investment on the proposed expansion project:

$450,000 / $5,000,000 = 9%

Yes, this is an acceptable project. The project generates a 9% return which is above the company's given hurdle rate of 8%.

5.) State whether the proposed project would increase or decrease each division's ROI:

Division A - Increase
Division B - Decrease
Division C - Increase

Both Division A and Division C would accept this project because its ROI is greater than either divisions current ROI. Therefore, the project would increase the ROI for either A or C. However, DIvision B currently has an ROI of 10% so the project would actually decrease the divisions ROI if accepted. Even though the project exceeds Wescott's hurdle rate. Division B would prefer to reject the project.

6.) Compute the new ROI and residual income for each division if the project was implemented within that division:

ROI Residual Income (Loss)

Division A 6.50% $(199,000)

Division B 9.28% $88,600

Division C 7.83% $(14,300)

ROI Division A = ($415,000 + 450,000) / ($8,300,000 + $5,000,000) = 6.50%

RI Division A = ($415,000 + $450,000) - (($8,300,000 + $5,000,000) X 8%) = $(199,000)

ROI Division B = ($193,000 + $450,000) / ($1,930,000 + $5,000,000) = 9.28%

RI DIvision B = ($193,000 + $450,000) - (($1,930,000 + $5,000,000) X 8%) = $88,600

ROI Division C = ($192,900 + $450,000) / ($3,215,000 + $5,000,000) = 7.83%

RI Division C = ($192,900 + $450,000) - (($3,215,000 + $5,000,000) X 8%) = $(14,300)

	Created by Mariah Bruce over 4 years ago

Accounting (Decentralized Performance Evaluation) Note on Exercises, created by Mariah Bruce on 04/06/2020.

Exercises