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ROI using the DuPont method and Residual Income

The Empire Hotel is a full-service hotel in a large city. Empire is organized into three departments
that are treated as investment centers. Budget information for the coming year for these three departments
is shown below. The managers of each of the departments are evaluated and bonuses are awarded each year based on ROI.

Empire Hotel
Hotel Rooms Restaurants Health Club--Spa
Average invevestment $8,000,000.00 $5,000,000.00 $1,000,000.00
Sales revenue $10,000,000.00 $2,000,000.00 $600,000.00
Operating expenses $8,500,000.00 $1,250,000.00 $450,000.00
Operating earnings $1,500,000.00 $750,000.00 $150,000.00

Instructions

a. Compute the ROI for each department. Use the DuPont method to analyze the return on sales and capital turnover.
b. Assume the Health Club--Spa is considering installing new exercise equipment. Upon investigating, the manager of thedivision fins that the equipment would cost $50,000 and that sales revenue would increase by $8,000 per year as a resultof the new equipment. What is the ROI of the investment in the new exercise equipment? What impact does the investment in the exercise equipment have on the Health Club--Spa's ROI? Would the manager of the Health Club--Spa be motivated to undertake such an investment?

c. Compute the residual income for each department if the minimum required return for the Empire Hotel is 17 percent. What would be the impact of the investment in (b) on the Health Club--Spa's residual income?

Solution Preview

The Empire Hotel is a full-service hotel in a large city. Empire is organized into three departments
that are treated as investment centers. Budget information for the coming year for these three departments
is shown below. The managers of each of the departments are evaluated and bonuses are awarded each year based on ROI.

Empire Hotel
Hotel Rooms Restaurants Health Club--Spa
Average invevestment $8,000,000.00 $5,000,000.00 $1,000,000.00
Sales revenue $10,000,000.00 $2,000,000.00 $600,000.00
Operating expenses $8,500,000.00 $1,250,000.00 $450,000.00
Operating ...

Solution Summary

This discusses the steps to compute the ROI using the DuPont method and Residual Income

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