Lathrop Fishing Reels, Inc., has two divisions-Fly and Cast. The Following segmented financial information is for the
Question:
Lathrop Fishing Reels, Inc., has two divisions-Fly and Cast. The Following segmented financial information is for the most recent fiscal year:
Fly Division | Cast Division | |
Sales | $6,000,000 | $10,000,000 |
Cost of Goods Sold | 2,500,000 | 4,000,000 |
Allocated Overhead | 375,000 | 625,000 |
Selling and administrative expenses | 2,100,000 | 3,950,000 |
The Fly Division had average operating assets totaling $5,700,000 for the year, and the Cast division had average operating assets of $9,600,000 for the year. Assume the cost of capital rate is 10 percent, and the company’s tax rate is 30 percent.
- Prepare a segmented income statement. Include the profit margin ratio for each division at the bottom of the segmented income statement.
- Calculate return on investment for each division
- Calculate residual income for each division.
- Summarize the answers to parts A, B, and C. What does this information tell us about each division?
- Assume each division of Lathrop Fishing Reels, Inc., is considering separate investment opportunities expected to yield a return of 16 percent, well above the company’s minimum required rate of return of 10 percent. Each investment opportunity will require $4,000,000 in average operating assets and yield operating income of $640,000.
- Using the information presented at the beginning of this problem, and the new investment proposal information presented previously, calculate each division's overall return on investment assuming the new investment is accepted.
- Compare your results in requirements e.1 to each division’s return on investment Prior to the new investment (calculated in requirement b). Which divisions will likely accept the proposal and which will likely reject the proposal using return on investment as the measure? Explain.
- using the information presented at the beginning of this problem, ending new investment proposal information presented previously, calculate each division's overall residual income assuming the new investment is accepted.
- Compare your results in requirement e.3 to each division’s residual income prior to new investment (calculated in requirement c). Which divisions will likely accept the proposal and which will likely reject the proposal using residual income as the measure? Explain.
- Assume the goal is to maximize company profit. Which measure do you think is best in deciding whether to accept a new investment proposal, return on investment or residual income? Explain.
Fly Division | Cast Division | |
Sales | 6,000,000 | 10,000,000 |
Cost of Goods sold | 2,500,000 | 4,000,000 |
Gross Profit | 3,500,000 | 6,000,000 |
Less: allocated overhead | 375,000 | 625,000 |
Less: Selling & Admin Exp | 2,100,000 | 3,950,000 |
Operating income | 1,025,000 | 1,425,000 |
Less: Tax (30%) | 307500 | 427500 |
Net Income (B) | 717,500 | 997,500 |
Profit Margin Ratio (B/A) | 0.11958333 | 0.09975 |
B. | Fly Division | Cast Division |
Operating Income: | 1,025,000 | 1,425,000 |
Average Operating Assets: | 5,700,000 | 9,600,000 |
Return on Investments: | 0.17982456 | 0.1484375 |
C. | Fly Division | Cast Division |
Operating Income | 1,025,000 | 1,425,000 |
Average Operating Assets | 5,700,000 | 9,600,000 |
x Cost of Capital | 10% | 10% |
Required Operating Income | 570000 | 960000 |
Residual Income | 455,000 | 465,000 |