E10-10 Determining the Impact of Various Transactions on Investment Turnover, RO
ID: 2521758 • Letter: E
Question
E10-10 Determining the Impact of Various Transactions on Investment Turnover, ROI, Residual Income, and Profit Margin [LO 10-4. 10-5] a variety of gear for water sports. Poseidon has three divisions Lake, River, and Ocean. Each division is managed as an investment center. During the current year, the Ocean division experienced the following transactions a. A special order was accepted at a selling price significantly loss than the ordinary selling price. The sale will not impact other sales because this was a one-time order and Ocean has excess capacity. The selling price was in excess of total variable costs b. One of three production managers in the Ocean Division submited his resignation. The position will not be filled due to current efficiencies experienced in the production c. Due to the y of open-ocean swimming during the Olympics, the company experienced a surge in sales during the summer months Sales returned to ther normal level for the remainder of the year d. Equipment costing $500,000 was purchased to replace fully depreciated, obsolete equipment. e. The after-tax cost of capital increased from 8 percent to 10 percent, with no efflect on the minimum required rate of return f. The company's eftective tax rate decreased from 35 percent to 30 percent Required Determine the impact on return on investment, residual income, and economic value added Use the table below to organize your answers Use (0) for increase, (D) for decrease, (N) for no effect, to determine the impact of the transaction Each transaction should be treated independentlyExplanation / Answer
a. As no additional fixed costs were associated with the special order, the entire contribution margin generated therefrom resulted in a commensurate increase in net operating income. Moreover, investment in assets remains unchanged. Therefore, all three measures of profitability should have increased.
b. As the position of the production manager was not filled, the operating expenses decreased, resulting in increase in net operating income. Consequently, ROI, RI and EVA all should have increased.
c. Increase in sales would lead to higher contribution margins, and fixed costs remaining unchanged, to higher net operating income.
d. An additional Investment in Operating Assets would lead to a decrease in all three values.
e. As minimum required rate of return remains unchanged, RI remains unaffected. But an increase in the cost of capital would lead to a decrease in EVA.
f. Residual Income = Net Operating Profit - ( Operating Assets x Minimum Required Rate of Return)
Economic Value Added = Net Operating Profit after Tax - ( Operating Assets * Cost of Capital )
A decrease in tax rates would not have effect on RI, whereas it would lead to an increase in EVA.
Transaction Return on Investment Residual Income Economic Value Added a. I I I b. I I I c. I I I d. D D D e. N N D f. N N IRelated Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.