Exercise 1: Evaluation of a Profit Strategic Business Unit (SBU)
The president of J. Hermosa Appliance Company notes that Department 3 has been operating
at a loss. The president reasons that profits will be increased by P9,000 by elimination of this
department in as much as costs of this department are in excess of revenue by this amount.
Department
1 2 3 4 Total
Revenue ₱ 132,000 ₱ 168,000 ₱ 125,000 ₱ 98,000 ₱ 523,000
Direct labor cost of
department 82,000 108,000 104,000 61,000 355,000
Allocated company
costs 30,000 36,000 30,000 25,000 121,000
Total cost ₱ 112,000 ₱ 144,000 ₱ 134,000 ₱ 86,000 ₱ 476,000
Net income (loss) ₱ 20,000 ₱ 24,000 -₱ 9,000 ₱ 12,000 ₱ 47,000
Required: Is the president correct? Prepare an analysis to indicate what the results would be
if Department 3 were eliminated.
Solution:
Department
1 2 4 Total
Revenue ₱ 132,000 ₱ 168,000 ₱ 98,000 ₱ 425,000
Direct labor cost of
department 82,000 108,000 61,000 251,000
Contribution margin of
the department ₱ 50,000 ₱ 60,000 ₱ 37,000 ₱ 147,000
Allocated company costs 121,000
Net income (loss) ₱ 26,000
J. Hermosa Appliance Company
Profitability Analysis of Department 3
Revenue ₱ 125,000
Less: Direct labor and expenses 104,000
Contribution to Indirect Expenses ₱ 21,000
Exercise 2 (Evaluation of an Investment Center)
The Cling Division has the following operating data:
Operating assets P400,000
Operating income P100,000
Minimum required rate of return 16%
Required:
1. Compute the ROI and RI for this division.
2. Assume that the Cling Division is presented with an investment product yielding a 20 percent
return on its investment requiring a cash outlay of P60,000. Would the manager of the Cling
division accept this investment under the ROI approach? How about under the RI approach?
Solution:
Required 1
Residual Income
Return on
(RI)
Investment (ROI)
Operating Assets ₱ 400,000 ₱ 400,000
Operating Income ₱ 100,000 ₱ 100,000
ROI
(100,000 / 400,000) 25%
Minimum required income
(16% * 400,000) 64,000
RI (100,000 - 64,000) ₱ 36,000
Required 2 – Under ROI Approach
Present New Project Overall
Operating Assets ₱ 400,000 ₱ 60,000 ₱ 460,000
Operating Income 100,000 12,000 112,000
ROI 25% 20% 24.35%
* 60,000 x 20% = 12,000
** 112,000/460,000 = 24.35%
REJECT
Under RI Approach
Present New Project Overall
Operating Assets ₱ 400,000 ₱ 60,000 ₱ 460,000
Operating Income ₱ 100,000 ₱ 12,000 ₱ 112,000
Minimum required return at 16% 64,000 9,600 73,600
RI ₱ 36,000 ₱ 2,400 ₱ 38,400
*60,000 x 16% = 9,600
ACCEPT
Exercise 3 (ROI, Comparison of Three Division)
Consider the following sales and operating data for the three divisions of a conglomerate:
Division X Division Y Division z
Sales ₱ 280,000 ₱ 360,000 ₱ 500,000
Operating Income 10,000 12,600 28,800
Operating Assets 40,000 70,000 180,000
Minimum required rate of return 10% 19% 20%
Required:
1. Compute the return on investment (ROI) for each division.
2. Assume that each division is provided with an investment opportunity that could
produce 20 percent return on investment.
Required 1
Division X Division Y Division z
Sales ₱ 280,000 ₱ 360,000 ₱ 500,000
Operating Income 10,000 12,600 28,800
Operating Assets 40,000 70,000 180,000
ROI 25% 18% 16%
* OI/OA = ROI
Required 2
Division X Division Y Division z
Sales ₱ 280,000 ₱ 360,000 ₱ 500,000
Operating Income 8,000 14,000 36,000
Operating Assets 40,000 70,000 180,000
ROI 20% 20% 20%
*OA x ROI = OI
Division X – Reject
Division Y – Accept
Division Z – Accept
