When you want to determine how well a company is performing, a good way to find out is by calculating its Return on Investment (ROI). You find the ROI by dividing operating income by average operating assets.
The following practice questions ask you to calculate the ROI for one company and then compare the ROIs for different divisions of another company.
Practice questions
Vegan Steaks had the best year ever, with sales of $4,500,000 and operating profit of $950,000. The balance sheet at the beginning of the year showed assets used in production with a cost of $20,000,000 and accumulated depreciation of $5,000,000. The company didn't buy any assets during the year but did have depreciation expense of $1,000,000. Calculate the ROI for the year.
Management of It'll Heal Medical Company are evaluating the performance of three divisions of the company. The Booboo Division had operating profit of $499 and on average used assets with a book value of $6,238. The Splint Division had operating profit of $350 and used average assets of $3,889. The Intensive Care Division had operating profit of $570 and average assets of $9,500. Which division is performing the best?
Answers and explanations
6.55%
You calculate ROI by dividing operating profit by the average book value of assets. Average assets are the sum of the book values divided by 2. The book value is cost less accumulated depreciation.
Beginning of the year book value:
End of year book value:
So, the average book value of assets is $14,500,000.
or ROI of 6.55%.
The Splint Division is performing the best with an ROI of 9%.
ROI is a good way to compare divisions of different sizes. You calculate ROI as operating profit divided by average assets.
or 8% ROI for the Booboo Division.
or 9% ROI for the Splint Division.
or 6% ROI for the Intensive Care Division.
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