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 $$35,600,000$ $$38,400,000$

Operating income $1,370,0001,520,000$

Average operating assets $3,200,0003,200,000$

Canned Division:

Year $1$ Year $2$

Sales $$11,600,000$ $$12,600,000$

Operating income $660,000570,000$

Average operating assets $5,850,0005,850,000$

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 $$28,000$ $$15,000$

Outlay $160,000110,000$

Allard's corporate headquarters has made available up to $$530,000$ 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 $1$

$16,800$

Fruit Pouch residual income $ fill in the blank $2$

$7,300$

$2.$ 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 Box

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

Profit

$ fill in the blank $9$