Y and Z are two divisions of a large company that operate in similar markets. Division Y represents the original manufacturing trade of the business but Division Z is a relatively new service/maintenance business and has seen considerable growth in its first two years of operation. The divisions are treated as investment centers and every month they each prepare an operating statement to be submitted to the parent company. Operating statements for these two divisions for October are shown below:

Operating statements for October

	Y	Z
	$000	$000
Sales revenue	900	555
Less variable costs	345	312
Contribution	555	243
Less controllable fixed costs (includes depreciation on divisional assets)	98	42
Controllable income	460	201
Less apportioned central costs	338	180
Net income before tax	122	21
Total divisional net assets	$9.76m	$1.26m

The company currently has a target return on capital of 12% per annum. However, the company believes its cost of capital is likely to rise and is considering increasing the target return on capital. At present the performance of each division and the divisional management are assessed primarily based on Return on Investment (ROI).

Required:

(a) Calculate the annualized Return on Investment (ROI) for divisions Y and Z, and discuss the relative performance of the two divisions using the ROI data and other information given above.

(b) Calculate the annualized Residual Income (RI) for divisions Y and Z, and explain the implications of this information for the evaluation of the divisions' performance.

Answer rating: 100% (QA)

1 millions millions ROI Y Monthly Net 0122 0021 Inco... View the full answer