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Residual Income and Investment Decisions

Allard, Inc., presented two years of data for its Frozen Foods Division and its Canned Foods Division.

Frozen Foods Division:
	Year 1	Year 2
Sales	$35,100,000	$37,800,000
Operating income	1,360,000	1,510,000
Average operating assets	6,800,000	6,800,000

Canned Division:
	Year 1	Year 2
Sales	$11,500,000	$12,500,000
Operating income	650,000	500,000
Average operating assets	5,650,000	5,650,000

At the end of Year 2, the manager of the Canned Division is concerned about the division's performance. As a result, he is considering the opportunity to invest in two independent projects. The first is juice boxes for elementary school children. The second is fruit and veggie pouches for kids on the go. Without the investments, the division expects that Year 2 data will remain unchanged. The expected operating incomes and the outlay required for each investment are as follows:

	Juice Box	Fruit Pouch
Operating income	$28,000	$15,100
Outlay	190,000	140,000

Allard's corporate headquarters has made available up to $550,000 of capital for this division. Any funds not invested by the division will be retained by headquarters and invested to earn the company's minimum required rate of return, 7 percent.

Required:

1. Compute the residual income for each of the opportunities. (Round to the nearest dollar.)

Juice Box residual income	$ fill in the blank 1
Fruit Pouch residual income	$ fill in the blank 2

2. Compute the divisional residual income for each of the following four alternatives: (Round to the nearest dollar.)

a. The juice box is added. $ fill in the blank 3

b. The fruit pouch is added. $ fill in the blank 4

c. Both investments are added. $ fill in the blank 5

d. Neither investment is made; the status quo is maintained. $ fill in the blank 6

Assuming that divisional managers are evaluated and rewarded on the basis of residual income, which alternative do you think the divisional manager will choose?

Juice BoxFruit PouchBoth projectsStatus quo

3. Assuming that management acts as you recommend in requirement 2, compute the change in profit (loss) from the divisional manager's investment decision.

ProfitLoss

$ fill in the blank 9

Was the correct decision made?

YesNo