The Southern Division Of Amelia Corporation Had Sales Of

The Southern Division Of Amelia Corporation Had Sales Of

Question 1: The Southern Division of Amelia Corporation had sales of $6,500,000 and operating income of $1,200,000 last year. The total assets of the Southern Division were $3,000,000, while current liabilities were $450,000. Amelia Corporation's target rate of return is 10%, while its weighted average cost of capital is 6%. The effective tax rate for the company is 30%. What is the Southern Division's Return on Investment (ROI)?

Question 2: The Pasta Division of Whole Grain Corporation had sales of $5,500,000 and operating income of $1,375,000 last year. The total assets of the Pasta Division were $2,750,000, while current liabilities were $330,000. Whole Grain Corporation's target rate of return is 12%, while its weighted average cost of capital is 8%. The effective tax rate for the company is 30%. What is the Pasta Division's Residual Income (RI)? What is the Pasta Division's capital turnover?

Paper For Above instruction

Introduction

The evaluation of division performance within corporations is essential for strategic management and resource allocation. Two common financial metrics used for this purpose are Return on Investment (ROI) and Residual Income (RI). ROI measures the efficiency of a division in generating profit from its assets, while RI assesses the excess profit relative to a required rate of return, considering the division's capital investment. This paper calculates these metrics for two divisions—Amelia Corporation’s Southern Division and Whole Grain Corporation’s Pasta Division—using provided financial data to analyze their performance and financial health comprehensively.

Calculation of the Southern Division's ROI

The Return on Investment (ROI) is a key indicator expressing the division’s operating income relative to its assets. It is calculated as:

ROI = Operating Income / Total Assets

For the Southern Division of Amelia Corporation:

- Operating income = $1,200,000

- Total assets = $3,000,000

Therefore:

ROI = $1,200,000 / $3,000,000 = 0.4 or 40%

This ROI indicates that the Southern Division generated a 40% return based on its assets last year, which is well above typical corporate benchmarks and suggests efficient asset utilization.

Adjusted ROI Considering Tax Effects

While ROI is often presented pre-tax, adjusting for taxes gives a more realistic picture of the division's profitability.

- Tax rate = 30%

- After-tax operating income = Operating income × (1 - Tax rate) = $1,200,000 × (1 - 0.3) = $1,200,000 × 0.7 = $840,000

The after-tax ROI is:

After-tax ROI = $840,000 / $3,000,000 = 0.28 or 28%

This suggests that after accounting for taxes, the division’s effectiveness is somewhat lower but still indicates high efficiency.

Residual Income for the Pasta Division

Residual Income (RI) measures the division’s earning surplus over a minimum required return, factoring in the division’s invested capital and the target rate of return. It is calculated as:

RI = Operating Income – (Target Rate of Return × Total Assets)

For the Pasta Division:

- Operating income = $1,375,000

- Total assets = $2,750,000

- Target rate of return = 12%

Calculating RI:

RI = $1,375,000 – (0.12 × $2,750,000) = $1,375,000 – $330,000 = $1,045,000

This positive RI indicates that the division exceeds the minimum required return, contributing value to the corporation.

Calculation of Capital Turnover for the Pasta Division

Capital turnover measures how efficiently a division uses its assets to generate sales:

Capital Turnover = Sales / Total Assets

For the Pasta Division:

Capital Turnover = $5,500,000 / $2,750,000 = 2.0

This indicates that for every dollar invested in assets, the division generates $2 in sales, a sign of effective asset utilization.

Discussion and Implications

The Southern Division’s high ROI suggests excellent operational efficiency. However, the analysis should also consider industry benchmarks for a more contextual understanding. The after-tax ROI of 28% signifies strong profitability after taxes, vital for investment decisions. For the Pasta Division, a positive residual income of over $1 million reflects its value-adding capacity. Its capital turnover ratio shows effective utilization of assets, which is desirable for management to maintain or improve.

Residual income and ROI are instrumental to understanding division performance beyond simple profit metrics; they help identify not just profitability but also efficiency and value creation. Firms often use these metrics to incentivize managers, allocate resources effectively, and strategize operational improvements.

Conclusion

Financial performance metrics like ROI, residual income, and capital turnover provide comprehensive insights into division efficiencies and value creation. The Southern Division of Amelia Corporation demonstrates a high ROI post-taxes, indicating effective use of assets, while the Pasta Division’s positive residual income and strong capital turnover reflect its profitability and asset efficiency. These measures are essential for strategic decision-making, performance evaluation, and resource allocation within large corporations.

References

  • Drury, C. (2013). Management and Cost Accounting. Cengage Learning.
  • Horngren, C. T., Sundem, G. L., Stratton, W. O., & Burgstahler, D. (2014). Introduction to Management Accounting. Pearson.
  • Garrison, R. H., Noreen, E. W., & Brewer, P. C. (2018). Managerial Accounting. McGraw-Hill Education.
  • Kaplan, R. S., & Norton, D. P. (1996). The Balanced Scorecard. Harvard Business Review.
  • Anthony, R. N., & Govindarajan, V. (2007). Management Control Systems. McGraw-Hill/Irwin.
  • Hawawini, G., & Viallet, C. (2011). Financial Management for Executives and Entrepreneurs. South-Western Cengage Learning.
  • Emmanuel, C., Otley, D., & Merchant, K. (2016). Accounting for Management Control. Routledge.
  • Financial Times. (2023). Corporate performance metrics and analysis reports.
  • Investopedia. (2023). Residual Income Definition and Calculation. https://www.investopedia.com
  • Corporate Finance Institute. (2023). Asset Utilization Ratios and Performance Metrics.

Related Assignments