• Hotel Ownership: Hotels owned and operated by Starwood.
• Vacation Ownership: Resort properties developed, owned, and operated for timeshare vacation owners.
Financial information for each division, from a recent annual report, is as follows (in millions):
Hotel | Vacation
Ownership | Ownership
Revenues $4,383 | $ 688
Income from operations 571 | 105
Total assets 6,440 | 2,139
a. Use the DuPont formula to determine the return on investment for each of the Starwood business divisions. Round whole percents to one decimal place and investment turnover to two decimal places.
b. Determine the residual income for each division, assuming a minimum acceptable income of 5% of total assets. Round minimal acceptable return to the nearest million dollars.
c. Interpret your results.
Answer:
a.
Rate of Return
on Investment =
Income from Operations
Revenues
× Revenues
Hotel Ownership: $571 ×
$4,383
$4,383 $6,440
= 13.0% × 0.68
= 8.8% (rounded)
Vacation Ownership: $105 ×
$688
$688 $2,139
= 15.3% × 0.32
= 4.9% (rounded)
b. Hotel
Ownership
Income from operations………………………………
Less: Minimum return (5% of assets)……………
Residual income (loss)………………………………
* $6,440 × 5%
** $2,139 × 5%
$571
322*
$249
c. The Vacation Ownership (VO) segment has the weakest return on investment,
which is mainly the result of a weak investment turnover. The VO segment earns
profit margins that are higher than the profit margins in the Hotel Ownership (HO)
segment (15.3% vs. 13.0%). However, weak investment turnover is causing the
ROI for the VO segment to be less than the assumed minimum acceptable return.
The residual income is negative for VO, which is consistent with a ROI less than the
acceptable 5% minimum return. This weak performance is due primarily to the
deterioration in the real estate market that has occurred in recent years. The
profit margin and investment turnover in the VO segment are closely tied to the
strength of the real estate market and the overall economy, both of which
deteriorated significantly in the preceding years.
The HO segment ROI is also affected by the global economy, but is still generating
a solid ROI. Stable profit margins and investment turnover generate a ROI that is
above the minimum acceptable return. The residual income is positive, which is
consistent with a ROI that is greater than the 5% minimum return.