91Ó°ÊÓ

Data for the North, East, South, and West divisions of Tor Max Semiconductor Communication Company are as follows: \begin{tabular}{lcccccc} & Sales & Income from Operations & Invested Assets & Rate of Return on Investment & Profit Margin & Investment Turnover \\ \hline North & \(\$ 425,000\) & (a) & (b) & \(20 \%\) & \(10 \%\) & \((\mathrm{c})\) \\\ East & (d) & \(\$ 50,000\) & \((\mathrm{e})\) & \((\mathrm{f})\) & \(8 \%\) & \(1.25\) \\\ South & \(\$ 400,000\) & \((\mathrm{~g})\) & \(\$ 125,000\) & \(12 \%\) & \((\mathrm{~h})\) & (i) \\ West & \(\$ 750,000\) & \(\$ 180,000\) & \(\$ 1,250,000\) & (j) & (k) & (l) \end{tabular} a. Determine the missing items, identifying each by the letters (a) through (1). b. Determine the residual income for each division, assuming that the minimum acceptable rate of return established by management is \(9 \%\). c. Which division is the most profitable in terms of (1) return on investment and (2) residual income?

Step by step solution

01

Calculate Income from Operations - North

Given that the Rate of Return on Investment (ROI) is 20% for the North division, use the formula: \( \text{ROI} = \frac{\text{Income from Operations}}{\text{Invested Assets}} \). Given Profit Margin = 10% and Sales = $425,000, we find Income from Operations: \( \,\text{Income from Operations} = \text{Sales} \times \text{Profit Margin} = 425,000 \times 0.10 \).Thus, calculate: \( \,\text{Income from Operations} = 42,500 \) (answer to (a)).

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Key Concepts

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

Return on Investment (ROI)

The term 'Return on Investment (ROI)' is a well-known performance measure used to evaluate the efficiency of an investment or compare the efficiency of a number of different investments. ROI attempts to directly measure the amount of return on a particular investment, relative to the investment’s cost.
To calculate ROI, the formula is:

• \( ROI = \frac{\text{Income from Operations}}{\text{Invested Assets}} \times 100 \% \)

This formula helps businesses assess how well they are using their invested capital to generate operational income. If a division of a company reports a high ROI, it suggests that the division is using its assets efficiently compared to divisions with a lower ROI.
In the example of Tor Max Semiconductor, the ROI for the North division is 20%, indicating a significant return based on the invested capital. It signifies that this division has managed to efficiently utilize its assets to generate a commendable return. Understanding ROI is crucial for managers to make informed decisions about asset allocation.

Profit Margin

Profit margin is a financial metric used to assess a company's profitability. It tells you what percentage of sales has turned into profits and is an indication of the efficiency of cost management within a company.
The formula for calculating profit margin is:

• \( \text{Profit Margin} = \frac{\text{Income from Operations}}{\text{Sales}} \times 100 \% \)

A higher profit margin indicates that a company retains more cents from every dollar of sales, suggesting effective control over expenses.
In our example, the North division has a profit margin of 10%. This means that for every dollar of sales, the North division earns 10 cents of income. Analyzing profit margin can help companies improve profitability by adjusting pricing strategies, controlling costs, and enhancing sales performance.

Residual Income

Residual income is a measure of absolute profitability. It represents the actual amount of income left after subtracting the required return on invested capital. Residual income provides insight into the profitability above and beyond the minimum expected return, which can guide investment allocation decisions.
The formula for residual income is:

• \( \text{Residual Income} = \text{Income from Operations} - (\text{Invested Assets} \times \text{Minimum Required Rate of Return}) \)

In the Tor Max Semiconductor exercise, the minimum acceptable rate of return is 9%. Calculating residual income allows each division to be ranked by absolute profits, which is useful when comparing divisions with different asset bases.
This metric is important because it accounts for the cost of capital and helps managers to ensure their investments generate more revenue than the cost of financing those investments. It emphasizes generating income above the baseline of required returns.

Investment Turnover

Investment turnover is a measure that captures the efficiency with which a company utilizes its assets to generate sales. It reflects the company's ability to produce revenues from its assets.
The formula used to calculate investment turnover is:

• \( \text{Investment Turnover} = \frac{\text{Sales}}{\text{Invested Assets}} \)

A higher investment turnover ratio indicates a company is making good use of its assets to generate sales, suggesting better efficiency.
In our case study, the East division reports an investment turnover of 1.25, meaning that for every dollar invested in assets, the division generates $1.25 in sales. Understanding and optimizing investment turnover can help businesses use their resources more effectively, leading to increased sales without necessarily needing to increase asset investments.