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Divisional contribution Margin $700,000 Profit Margin Controllable 320,000 Profit Margin traceable 294,400 Average assed investment $1,280,000 Company uses responsibility account concepts when evaluating performance, the division manager is contemplating the following three investments
Divisional contribution Margin $700,000
Profit Margin Controllable 320,000
Profit Margin traceable 294,400
Average assed investment $1,280,000
Company uses responsibility account concepts when evaluating performance, the division manager is contemplating the following three investments. He can invest up to $400,000.
No 1 No 2 No 3
Cost $250,000 $300,000 $400,000
Expected Income 50,000 54,000 96,000
Calculate ROI for three investments
What is division managers current ROI, computed by using responsibility acct concepts.
Which of the three investments would be selected if the managers focus is on divisional performance? Why?
Expert Solution
1.
No 1: ROI = Income/Investment = 50,000/250,000 = 20%
No 2: ROI = Income/Investment = 54,000/300,000 = 18%
No 3: ROI = Income/Investment = 96,000/400,000 = 24%
2. division managers current ROI = Income/Average asset investment = Profit Margin traceable/ Average asset investment = 294,400/1,280,000 = 23%
3. Let's calculate the expected ROI for the three investment:
No. 1: ROI = Income/Investment = (Profit Margin traceable + Expected Income)/(Average asset investment+ Cost)
= (294,400+50,000)/(1,280,000+250,000) = 22.5%
No. 2: ROI = Income/Investment = (Profit Margin traceable + Expected Income)/(Average asset investment+ Cost)
= (294,400+54,000)/(1,280,000+300,000) = 22.05%
No. 3: ROI = Income/Investment = (Profit Margin traceable + Expected Income)/(Average asset investment+ Cost)
= (294,400+96,000)/(1,280,000+400,000) = 23.24%
So investment No. 3 will be selected because it has the biggest ROI.
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