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 as follows. The managers of each of the departments are evaluated and bonuses are awarded each year based on ROI. Average investment Sales revenue Operating expenses Operating earnings Empire Hotel Hotel Rooms $ 7,722,000 $ 10,000,000 8,887,000 $ 1,113,000 Restaurants $4,847,000 $ 2,000,000 1,342,000 $ 658,000 Health Spa $1,172,000 600,000 430,000 $ 170,000 $ Required: a. Compute the ROI for each department. Use the DuPont method to analyze the return on sales and capital turnover. Assume the Health Spa is considering installing new exercise equipment. Upon investigating, the manager of the division finds that the equipment would cost $40,000 and that operating earnings would increase by $8,000 per year as a result of the new equipment. b-1. What would be the ROI of investment in the new exercise equipment and Health Spa? b-2. Would the manager of the Health Spa be motivated to undertake such an investment? c-1. Compute the residual income for each department if the minimum required return for the Empire Hotel is 17 percent. c-2. What would be the impact of the investment on the Health Spa's residual income?

ROI stands for Return on Investment. It is a profitability ratio and measures the financial performance of a firm or a division based on the average investment made in that firm or division. Residual income is also a measure to determine the profitability of the firm. The residual income is affected by the required rate of return as expected by management.a. Using the DuPont method, the ROI of a division can be determined with the help of the following formula: -With the help of the above formulas, we can determine the ROI of each division as follows: - Hotel RoomsRestaurantsHealth SpaAAverage Investment7,722,0004,847,0001,172,000BSales revenue10,000,0002,000,000600,000COperating expenses8,887,0001,342,000430,000DOperating earnings1,113,000658,000170,000EReturn on Sales (D/B)11.13%32.90%28.33%FCapital Turnover (B/A)1.2950012950.4126263670.511945392GROI (E x F)14.41%13.58%14.51%b. 1. The ROI of investment in new equipment will be as follows:Therefore, the ROI of investment in new equipment is 20%.ROI of Health Spa (with new equipment) can be determined as follows:Therefore, the ROI of Heath Spa after making an investment in new equipment is 14.96%.b. 2. Since the ROI of the new investment is more than the ROI of the division and it will increase the overall ROI of the division as well, the manager will be motivated to undertake this investment.c. 1. Determine the residual income of all the divisions as follows: - Hotel RoomsRestaurantsHealth SpaAAverage Investment7,722,0004,847,0001,172,000BOperating earnings1,113,000658,000170,000CMinimum required return (A x 17%)1,312,740823,990199,240DResidual Income (B-C)-199,740-165,990-29,240c. 2. Determining the impact of investment on residual income as follows: - Health SpaHealth SpaIncrease (Decrease)before InvestmentAfter InvestmentAAverage Investment11,72,0001212000BOperating earnings1,70,000178000CMinimum required return (A x 17%)1,99,240206040DResidual Income (B-C)-29,240-280401,200Therefore, the residual income of Health Spa has increased by $1,200 after investing in new equipment.a. Hotel RoomsRestaurantsHealth SpaROI 14.41%13.58%14.51%b - 1The ROI of new equipment is 20% and the ROI of the Health Spa is 14.69% (with new equipment)b - 2Since the ROI of new equipment is more than the division's ROI, the manager will be motivated by such investment.c - 1Hotel RoomsRestaurantsHealth SpaResidual Income-199,740-165,990-29,240c - 2The residual income of Health Spa will be increased by $1,200 or in other words, the residual loss will be decreased by $1,200.

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