91Ó°ÊÓ

Hilton Hotels Corp. provides lodging services around the world. The company is separated into three major divisions: \- Hotel ownership: Hotels owned and operated by Hilton. \- Managing and franchising: Hotels franchised to others or managed for others. \- Timeshare: Resort properties managed for timeshare vacation owners. Financial information for each division, from a recent annual report, is as follows (in millions): $$ \begin{array}{lrrr} & \begin{array}{c} \text { Hotel } \\ \text { Ownership } \end{array} & \begin{array}{c} \text { Managing and } \\ \text { Franchising } \end{array} & \text { Timeshare } \\ \hline \text { Revenues } & \$ 2,388 & \$ 342 & \$ 320 \\ \text { Income from operations } & 470 & 290 & 86 \\ \text { Total assets } & 4,542 & 668 & 333 \end{array} $$ a. Use the DuPont formula to determine the return on investment for each of the Hilton business divisions. Round to four digits after the decimal place. b. Determine the residual income for each division, assuming a minimum acceptable income of 15% of total assets. c. Interpret your results.

Step by step solution

01

Calculate Return on Investment (ROI) using the DuPont Formula

The DuPont formula for Return on Investment (ROI) is given by: \( \text{ROI} = \frac{\text{Income from Operations}}{\text{Total Assets}} \). For each Hilton division, the ROI is calculated as follows:- **Hotel Ownership**: \( \frac{470}{4542} = 0.1035 \)- **Managing and Franchising**: \( \frac{290}{668} = 0.4341 \)- **Timeshare**: \( \frac{86}{333} = 0.2583 \)These results indicate that the ROI is highest for the Managing and Franchising division and lowest for the Hotel Ownership division.

02

Calculate Residual Income for Each Division

Residual income is calculated using the formula \( \text{Residual Income} = \text{Income from Operations} - (\text{Minimum Acceptable Income Rate} \times \text{Total Assets}) \).The minimum acceptable income rate is 15%.Calculate residual income for each division:- **Hotel Ownership**: \( 470 - (0.15 \times 4542) = 470 - 681.3 = -211.3 \)- **Managing and Franchising**: \( 290 - (0.15 \times 668) = 290 - 100.2 = 189.8 \)- **Timeshare**: \( 86 - (0.15 \times 333) = 86 - 49.95 = 36.05 \)Hotel Ownership has negative residual income, indicating it didn't meet the minimum acceptable income.

03

Interpret the Results

From the calculations, the Managing and Franchising division has the highest ROI and significant positive residual income, indicating strong financial performance. The Timeshare division also has a substantial ROI but much lower residual income compared to Managing and Franchising. Hotel Ownership has the lowest ROI and negative residual income, suggesting it is underperforming compared to the required benchmark.

Unlock Step-by-Step Solutions & Ace Your Exams!

• Full Textbook Solutions

  Get detailed explanations and key concepts

• Unlimited Al creation

  Al flashcards, explanations, exams and more...

• Ads-free access

  To over 500 millions flashcards

• Money-back guarantee

  We refund you if you fail your exam.

Over 30 million students worldwide already upgrade their learning with 91Ó°ÊÓ!

Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Return on Investment

The concept of Return on Investment (ROI) is essential in financial analysis because it indicates how well a company is using its assets to generate income. ROI is calculated by dividing the **income from operations** by the **total assets** involved. It tells you how much profit is generated for every dollar invested in assets.

ROI serves as a useful measurement for comparing the efficiency and profitability of various divisions within a company. In Hilton Hotels Corp, for instance, the Managing and Franchising division shows the highest ROI, suggesting that it is highly efficient in using its resources to generate income.

• **High ROI** signifies an effective use of assets.
• **Low ROI** could indicate inefficiencies, as seen with Hotel Ownership.

A high ROI isn't just appealing to investors; it also means the division is contributing well to overall company profitability.

Residual Income

Residual Income differs from ROI as it considers the cost of capital or the minimum acceptable income for the assets used. It is calculated by subtracting the product of the minimum acceptable rate and the total assets from the income from operations.

In Hilton's case, the minimum acceptable income rate is 15%. This measure gives insight into whether a division is producing more than the benchmark income required to justify the asset investment. If the residual income is positive, the division is generating more profit than the set benchmark.

• **Positive Residual Income**: Indicates financial success beyond expectations, as with Managing and Franchising.
• **Negative Residual Income**: Suggests underperformance, like in Hotel Ownership.

This metric helps managers identify problem areas and make informed decisions on where improvements are necessary or further investments might be profitable.

DuPont Formula

The DuPont Formula is a detailed approach to calculate ROI by breaking it down into its components. It shows how different factors affect profitability and asset efficiency. The formula calculates ROI as the product of Profit Margin, Asset Turnover, and Equity Multiplier.

Each part of the formula offers unique insights:

• **Profit Margin**: Reflects profitability as a percentage of sales. Higher margins mean better control of costs relative to revenues.
• **Asset Turnover**: Measures how effectively a company uses its assets to generate sales. Higher turnover indicates more efficient use of assets.
• **Equity Multiplier**: Provides a sense of financial leverage. A higher equity multiplier means more assets are funded by equity, suggesting potential financial pressure.

For Hilton's divisions, using the DuPont Formula can help pinpoint why ROI figures differ and illuminate areas for improvement or investment.