Exercises

ROI & Residual Income A

Violet Company has the following financial data: Sales = $520,000 Net Operating Income = $310,000 Average Invested Assets = $940,000 Hurdle Rate = 12% Calculate Violet's return on investment and its residual income. SOLUTION: Return on Investment (ROI) = Net Operating Income/Average Invested Assets                                                   = $310,000/$940,000                                                   = 32.98% Residual Income (Loss) = Operating Income - (Average Invested Assets X Hurdle Rate)                                           = $310,000 - ($940,000 X 10%)                                           = $310,000 - $94,000                                           = $216,000

ROI & Residual Income B

Augusta Corp's Golf Division has the following financial data: Sales Revenue = $200,000  Cost of Goods Sold = $105,000  Operating Expenses = $35,000 Average Invested Assets = $900,000  Hurdle Rate = 12% Calculate the Golf Division's return on investment and its residual income: SOLUTION: Net Operating Income = Sales Revenue - Cost of Goods Sold - Operating Expenses                                          = $200,000 - $105,000 - $35,000                                          = $60,000 Return on Investment (ROI) = Net Operating Income / Average Invested Assets                                                   = $60,000 / %90,000                                                   = 6.7% Residual Income (Loss) = Net Operating INcome - (Average Invested Assets X Hurdle Rate)                                           = $60,000 - ($900,000 X 12%)                                           = $60,000 - $108,000                                           = $(48,000)

ROI & Residual Income C

Coolbrook Company has the following financial data:                                                                River Division     Stream Division Sales Revenue                                        $1,200,000          $1,800,000 COGS and operating expenses               (900,000)          (1,300,000) Net operating Income                              $300,000             $500,000 Average Invested Assets                       $1,200,000          $1,800,000    The company's hurdle rate is 6%.                                                                                                                                                        SOLUTION: ROI = Net Operating Division / Average Invested Assets Residual Income (Loss) = Net Operating Income - (Average Invested Assets X Hurdle Rate)                                                                                                                                                         1.) Calculate the Return on Investment (ROI) and residual income for each division last year:      River Division                  ROI = $300,000 / $1,200,000 = 25.00%                  Residual Income = $300,000 - ($1,200,000 X 6%) = $228,000                                                   Stream Division                  ROI = $500,000 / $1,800,000 = 27.80%                  Residual Income =   $500,000 - ($1,800,000 X 6%) = $392,000                                                                                                                                                         2.) Calculate ROI and residual income for each division for the independent situation where               operating income increases by 10%:       River Division                   ROI = ($300,000 X 110%) / $1,200,000 = 27.50%                   Residual Income = $330,000 - ($1,200,000 X 6%) = $258,000       Stream Division                   ROI = ($500,000 X 110%) / $1,800,000 = 30.56%                   Residual Income = $550,000 - ($1,800,000 X 6%) = $442,000                                                                                                                                                           3.) Caulculate ROI and residual income for each division for the independent situation where operating income decreases by 10%: River Division             ROI = ($300,000 X 90%) / $1,200,000 = 22.50%             Residual Income = $270,000 - ($1,200,000 X 6%) = $198,000 Stream Division             ROI = ($500,000 X 90%) / $1,800,000 = 22.50%             Residual Income (Loss) = $450,000 - ($1,800,000 X 6%) = $342,000                                                                                                                                                            4.) Calculate ROI and residual income for each division for the independent situation that follows: The company invests $250,000 in each division, an amount that generates $100,000 additional income per division: River Division             ROI = ($300,000 + $100,000) / ($1,200,000 + $250,000) = 27.59%             Residual Income = $400,000- ($1,450,000 X 6%) = $313,000 Stream Division             ROI = ($500,000 + $100,000) / ($1,800,000 + $250,000)  = 29.27%             Residual Income = $600,000 - ($2,050,000 X 6%) = $477,000                                                                                                                                                                5.) Calculate ROI and residual income for each division for the independent situation where Colbrook changes its hurdle rate to 10%. NO EFFECT on return on investment since it does not incorporate the hurdle rate. River Division             Residual Income = $300,000 - ($1,200,000 X 10%) = $180,000 Stream Division            Residual Income = $500,000 - ($1,800,000 X 10%) = $320,000  

ROA & Residual Income D

Wescott Company has three divisions: A, B, and C. The company has a hurdle rate of 8%. Selected operating data for the three divisions are as follows:                                                                      Division A                     Division B                     Division C Sales Revenue                                          $1,255,000                      $920,000                     $898,000 Cost of Goods Sold                                       776,000                        675,000                        652,000 Miscellaneous Operating Expenses             64,000                          52,000                          53,100 Interest and Taxes                                           48,000                          41,000                          41,500 Average Invested Assets                           8,300,000                     1,930,000                     3,215,000                                                                                                                                                                       SOLUTION: 1.) Compute ROI for each division: Division A ROI = $415,000 / $8,300,000 = 5% Division B ROI = $193,000 / $1,930,000 = 10% Division C ROI = $192,900 / $3,21,000 = 6%                                                                                                                                                                        2.) Compute the Residual Income for each division: Division A RI Division A = $415,000 - ($8,300,000 X 8%) = $(249,000) Division B RI Division B = $93,000 - ($1,90,000 X 8%) = $38,600 Division C RI Division C = $192,900 - ($3,215,000 X 8%) = $(64,300)                                                                                                                                                                       3.) Rank the divisions according to the ROI and residual income of each (best to worst): Division B, Division C, Division A                                                                                                                                                                       4.) Compute the Return on Investment on the proposed expansion project: Compute the return on investment on the proposed expansion project: $450,000 / $5,000,000 = 9% Yes, this is an acceptable project. The project generates a 9% return which is above the company's given hurdle rate of 8%.                                                                                                                                                                        5.) State whether the proposed project would increase or decrease each division's ROI: Division A - Increase Division B - Decrease Division C - Increase Both Division A and Division C would accept this project because its ROI is greater than either divisions current ROI. Therefore, the project would increase the ROI for either A or C. However, DIvision B currently has an ROI of 10% so the project would actually decrease the divisions ROI if accepted. Even though the project exceeds Wescott's hurdle rate. Division B would prefer to reject the project.                                                                                                                                                                       6.) Compute the new ROI and residual income for each division if the project was implemented within that division:                                                                 ROI                                  Residual Income (Loss) Division A                                               6.50%                              $(199,000) Division B                                               9.28%                              $88,600 Division C                                               7.83%                              $(14,300)   ROI Division A = ($415,000 + 450,000) / ($8,300,000 + $5,000,000) = 6.50%             RI Division A = ($415,000 + $450,000) - (($8,300,000 + $5,000,000) X 8%) = $(199,000) ROI Division B = ($193,000 + $450,000) / ($1,930,000 + $5,000,000) = 9.28%             RI DIvision B = ($193,000 + $450,000) - (($1,930,000 + $5,000,000) X 8%) = $88,600 ROI Division C = ($192,900 + $450,000) / ($3,215,000 + $5,000,000) = 7.83%             RI Division C = ($192,900 + $450,000) - (($3,215,000 + $5,000,000) X 8%) = $(14,300)