Question 2.

The Central Division of Miller's Quarter Horse Company has sales of $4,500,000. It also has invested assets of $2,500,000 and operating expenses of $3,800,000. The company has established a minimum rate of return of 7%.

Required:

1. Determine the following for the Central Division:

• Profit Margin
• ROI using DuPont formula
• Residual Income

2. Miller has offered a new investment opportunity to the Central Division, which has a Return of Investment of 20% calculated as an operating income of $160,000 divided by the invested asset of $800,000.

Explain by undertaking required calculation, whether the manager of the Central division would undertake the additional investment opportunity if:

• He was paid a bonus based upon his divisions overall ROI.
• He was paid a bonus based upon his divisions overall RI

Solution:

	Intermediate working/formula
Income from operations	Sales Expense
Profit margin	Income from operation /Sales
Investment Turnover	Sales / Invested Assets
ROI using Du Pont formula	Profit Margin x Investment Turnover
Minimum Acceptable Income	Invested Assets x Minimum Desired ROI
Residual Income	Income from Operation Minimum Acceptable Income

Central Division

Before accepting the new investment:

ROI:

RI:

After accepting the new investment

ROI:

RI: