The Top Hat Division of Blandon's Fine Menswear had the following results last year (in thousands). Management's target rate of return is 24% and the weighted average cost of capital is 18%.
What is the Top Hat Division's Return on Investment (ROI)?
A)17.00%
B)10.00%
C)170.00%
D)5)10%

Question

The Top Hat Division of Blandon's Fine Menswear had the following results last year (in thousands).  Management's target rate of return is 24% and the weighted average cost of capital is 18%.
What is the Top Hat Division's Return on Investment (ROI)?
A)17.00% 
B)10.00% 
C)170.00% 
D)5)10%

Quizplus · Accepted Answer

ROI = (Operating Income / Average Operating Assets) x 100
Operating Income = Sales - Operating Expenses
Average Operating Assets = (Beginning Operating Assets + Ending Operating Assets) / 2

Using the given numbers:
Operating Income = $9,500 - $7,450 = $2,050
Average Operating Assets = ($46,450 + $50,950) / 2 = $48,700

Therefore, ROI = ($2,050 / $48,700) x 100 = 4.21%
This is below the target rate of return of 24%, indicating that the division is not performing as well as expected.

Alternatively, we can calculate the division's Residual Income and see if it is positive or negative:
Residual Income = Operating Income - (Average Operating Assets x WACC)
WACC = 18%
Average Operating Assets = $48,700
Residual Income = $2,050 - ($48,700 x 0.18) = -$4,666

Since the Residual Income is negative, it indicates that the division is not earning enough to cover the cost of capital and is incurring an economic loss.

Therefore, choice A) 17.00% is incorrect and the best choice is none of the above.

The Top Hat Division of Blandon's Fine Menswear Had the Following