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Question - Golden Seafood Ltd operates a chain of budget seafood restaurants. Golden Seafood is structured into two divisions: the Western Division and the Eastern Division. Each division operates as a separate stand-alone business and is designated as an investment centre. The Western Division owns all of its assets, while the Eastern Division leases most of its restaurant sites. The lease payments are treated as an expense.
The weighted average cost of capital, which is also the required rate of return, of Golden Seafood is 6%. The company income tax rate is 30%. For the purpose of calculating divisional return on investment (ROI) and residual income (RI), invested capital is defined as total assets, and divisional operating profit before tax is used.
The following data relate to financial performance for the last year.
Western Division
Eastern Division
Operating profit before tax
$65,000
$17,000
Total assets
574,000
86,000
Current liabilities
150,000
25,000
Required -
(a) Calculate the return on investment (ROI) for each division.
(b) Compare the performance of the two divisions using ROI. Is there any other information given in the question that needs to be taken into account when interpreting divisional performance using ROI?
(c) Calculate the residual income (RI) for each division. Should RI be used to compare the performance of the two divisions? Why?
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