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Using ROI and RI to evaluate investment centers

Tiger Paints is a national paint manufacturer and retailer. The company is segmented into five divisions: Paint Stores (branded retail locations), Consumer (paint sold through home improvement stores), Automotive (sales to auto manufacturers), International, and Administration. The following is selected divisional information for its two largest divisions: Paint Stores and Consumer:

Net Sales Revenue Operating Income Average Total Assets

Paint Stores\( 4,000,000 \) 476,000 $ 1,420,000

Consumer 1,300,000 196,000 1,585,000

Management has specified a 19% target rate of return.

Requirements

1. Calculate each division鈥檚 ROI. Round all of your answers to four decimal places.

2. Calculate each division鈥檚 profit margin ratio. Interpret your results.

3. Calculate each division鈥檚 asset turnover ratio. Interpret your results.

4. Use the expanded ROI formula to confirm your results from Requirement 1. Interpret your results.

5. Calculate each division鈥檚 RI. Interpret your results, and offer a recommendation for any division with negative RI.

6. Describe some of the factors that management considers when setting its minimum target rate of return.

Step by step solution

01

Computing ROI

Paint Stores

$\begin{array}{c}\text{ROI}=\frac{\text{Netincome}}{\text{Averagetotalasset}}脳100\\ =\frac{\$476,000}{\$1,420,000}脳100\\ =33.5211\%\end{array}$

Consumer

$\begin{array}{c}\text{ROI}=\frac{\text{Netincome}}{\text{Averageasset}}脳100\\ =\frac{\$196,000}{\$1,585,000}脳100\\ =12.3659\%\end{array}$

02

Computing profit margin ratio-

Paint Stores

$\begin{array}{c}\text{Profitmarginratio}=\frac{\text{Netincome}}{\text{Netsalesrevenue}}\\ =\frac{\$476,000}{\$4,000.000}\\ =0.119\end{array}$

Consumer

$\begin{array}{c}\text{Profitmarginratio}=\frac{\text{Netincome}}{\text{Netsalesrevenue}}\\ =\frac{\$196,000}{\$1,300.000}\\ =0.1507\end{array}$

03

Computing asset turnover ratio

Paint Stores

$\begin{array}{c}\text{AssetTurnoverRatio}=\frac{\text{NetSales}}{\text{AverageTotalAssets}}\\ =\frac{\$4,000,000}{\$1,420,000}\\ =2.8169\end{array}$

Consumer

$\begin{array}{c}\text{AssetTurnoverRatio}=\frac{\text{NetSales}}{\text{AverageTotalAssets}}\\ =\frac{\$1,300,000}{\$1,585,000}\\ =0.8201\end{array}$

04

Computing expanded ROI

Paint Stores

$\begin{array}{c}\text{ROI}=\text{Profitmarginratio}脳\text{Assetturnoverratio}脳100\\ \text{=0.119}脳2.8169脳\text{100}\\ \text{=33.5211\%}\end{array}$

Consumer

$\begin{array}{c}\text{ROI}=\text{Profitmarginratio}脳\text{Assetturnoverratio}脳100\\ \text{=0.1507}脳0.8201脳\text{100}\\ \text{=12.3659\%}\end{array}$

05

Computing RI

Paint Stores

$\begin{array}{c}\text{ResidualIncome}=\text{Operatingincome}鈭�\left(\text{Minimumrequiredrateofreturn}脳\text{Averageoperatingassets}\right)\\ =\$476,000鈭�\left(19\%脳\$1,420,000\right)\\ =\$476,000鈭�\$269,800\\ =\$206,200\end{array}$

Consumer

$\begin{array}{c}\text{ResidualIncome}=\text{Operatingincome}鈭�\left(\text{Minimumrequiredrateofreturn}脳\text{Averageoperatingassets}\right)\\ =\$196,000鈭�\left(19\%脳\$1,585,000\right)\\ =\$196,000鈭�\$301,150\\ =\left(\$105,150\right)\end{array}$

06

The factors that management considers when setting its minimum target rate of return

While setting theminimum target rate of return the management should consider the following factors-

Operating income

Average Investment in division

Desired residual income

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