Calculate ROI of two divisions with the expansion project

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Reference no: EM132736923

Question - Billings Company is a decentralised wholesaler with two autonomous divisions. The divisions are evaluated on the basis of return on investment (ROI), with year-end bonuses given to the divisional managers who have the highest ROIs. Operating results for the company's two divisions - X and Y for the most recent year are given below:

	Division X	Division Y
Sales	$10,500,000	$458,000
Cost of goods sold	6,000,000	316,000
Operating expenses	3,200,000	58,000
Invested capital at the beginning of the year	3,000,000	1,200,000
Invested capital at the end of the year	5,000,000	2,000,000

The company had an overall ROI of 15% last year. The company is considering an expansion project in the upcoming year. The project would be implemented by one of the two divisions. The following data relate to the project:

Expansion project
Sales	$2,000,000
Cost of goods sold	1,200,000
Operating expenses	640,000
Invested capital	1,000,000

Required -

(i) Calculate ROI of the two divisions with the expansion project and explain the likely reaction of each divisional manager towards the expansion. Show all computations to support your answer.

(ii) Explain the likely reaction of Billings Company's corporate management to the expansion. Show all computations to support your answer.

(iii) Calculate residual income (RI) of the two divisions with the expansion project and without the expansion project, and explain the likely reaction of each divisional manager towards the expansion, if the two divisions are evaluated on the basis of residual income (RI). Assume the minimum required rate is 12 per cent on invested capital.

Reference no: EM132736923

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