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Harbor Division has total assets (net of accumulated depreciation) of $633,000 at the beginning of year 1
Harbor Division has total assets (net of accumulated depreciation) of $633,000 at the beginning of year 1. Harbor also leases a machine for $18,000 annually. Expected divisional income in year 1 is $81,000 including $5,300 in income generated by the leased machine (after the lease payment). Harbor's cost of capital is 9 percent. Harbor can cancel the lease on the machine without penalty at any time and is considering disposing of it today (the beginning of year 1).
Required:
a. Harbor computes ROI using beginning-of-the-year net assets. What will the divisional ROI be for year 1 assuming Harbor retains the leased machine? (Enter your answer as a percentage rounded to 1 decimal place (i.e., 32.1).)
b. What would divisional ROI be for year 1 assuming Harbor disposes of the leased machine? (Enter your answer as a percentage rounded to 1 decimal place (i.e., 32.1).)
c. Harbor computes residual income using beginning-of-the-year net assets. What will the divisional residual income be for year 1 assuming Harbor retains the leased machine?
d. What would divisional residual income be for year 1 assuming Harbor disposes of the leased machine?
Expert Solution
1. Divisional ROI= After-tax Income/Divisional Assets
= 81,000/633,000*100
= 12.80%
2. Divisional ROI be for year 1 assuming Harbor disposes of the leased machine:
Expected Divisional income for Year 1= 81,000-5,300
= $75,700
Return On Investment= 75,700/633,000*100
= 11.96%
3. Residual Income of harbor Division for Year 1 Assuming Harbor Division Disposes of the Assets for its book Value
Cost of Invested Capital= Cost of capital * Divisional Assets
= 633,000*9%
= $56,970
Residual Income= After tax Income- Cost of invested Capital
= 81,000-56,970
= $24,030
4. Divisional residual income be for year 1 assuming Harbor disposes of the leased machine:
Residual Income= Net operating Income- (Required Return*Net Operating Assets)
= 75,700-{633,000*9%}
= 75,700- 56,970
= $18,730
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