The Southern Division of Amelia Corporation had sales of $61,000,000 and operating income of $200,000 last year. The total assets of the Southern Division were $2,000,000, while current liabilities were $500,000. Amelia Corporation's target rate of return is 6%, while its weighted average cost of capital is 5%. The effective tax rate for the company is 35%. What is the Southern Division's Return on Investment (ROI)?
A)0%
B)25%
C)10%
D)1000%

Question

Quizplus · Accepted Answer

ROI = Operating Income / Total Assets

First, we need to calculate the net operating income:
Net Operating Income = Operating Income x (1 - Tax Rate)
Net Operating Income = $200,000 x (1 - 0.35)
Net Operating Income = $130,000

Next, we need to calculate the weighted average cost of capital (WACC):
WACC = (Cost of Debt x (1 - Tax Rate) x Proportion of Debt) + (Cost of Equity x Proportion of Equity)
Assuming Amelia Corporation only uses equity financing (i.e. no debt), the WACC would simply be the cost of equity, which is 5%.

Now we can calculate ROI:
ROI = Net Operating Income / Total Assets
ROI = $130,000 / $2,000,000
ROI = 6.5%

Since the target rate of return is 6%, the Southern Division's ROI of 6.5% indicates that it is performing well and meeting its target. The correct answer is therefore (C) 10%.

The Southern Division of Amelia Corporation Had Sales of $61,000,000