E10-5 Calculating Return on Investment, Residual Income, Determining Effect of C
ID: 2522675 • Letter: E
Question
E10-5 Calculating Return on Investment, Residual Income, Determining Effect of Changes in Sales, Expenses, Invested Assets, Hurdle Rate on Each [LO 10-4, 10-5]
Solano Company has sales of $780,000, cost of goods sold of $510,000, other operating expenses of $38,000, average invested assets of $2,300,000, and a hurdle rate of 12 percent.
Required:
1. Determine Solano’s return on investment (ROI), investment turnover, profit margin, and residual income. (Do not round your intermediate calculations. Enter your ROI and Profit Margin percentage answer to the nearest 2 decimal places, (i.e., 0.1234 should be entered as 12.34%). Round your Investment Turnover answer to 4 decimal places.)
2. Several possible changes that Solano could face in the upcoming year follow. Determine each scenario’s impact on Solano’s ROI and residual income. (Note: Treat each scenario independently.) (Enter your ROI percentage answers to 2 decimal places, (i.e., 0.1234 should be entered as 12.34%.))
a. Company sales and cost of goods sold increase by 30 percent.
b. Operating expenses decrease by $12,000.
c. Operating expenses increase by 10 percent.
d. Average invested assets increase by $440,000.
e. Solano changes its hurdle rate to 18 percent.
Return on Investment % Investment Turnover Profit Margin % Residual Income (Loss)Explanation / Answer
(I)
1). Return on investment= (Total Operating income/Average assets)*100
=(232000/2300000)*100= 10.09%
2) Total Operating income= Sales-COGS-Operating Exp
=780000-510000-38000
=232000
3) profit margin=(Sales-COGS)/Sales
=(780000-510000)/780000
=35%
3) Residual Income= Net Operating income-(Minimum Required return on assets*Average Operating Assets)
=232000-(2300000*0.12)
-44000
(II)
(a) 30% Increase in sales and cost of goods sold
1). Return on investment= (Total Operating income/Average assets)*100
=(313000/2300000)*100= 13.61%
Total Operating income= Sales-COGS-Operating Exp
Sales 780000*130% 1014000
CoGS =510000*130% 663000
Operating cost 38000
Net Op. Income 313000
=313000-(2300000*0.12) =37000
(II) (b)
Operaing Expense decrease by $12000
(-32000)
Note:
1). Return on investment= (Total Operating income/Average assets)*100
=244000/2300000*100
=10.61%
Total Operating income= Sales-COGS-Operating Exp
=780000-510000-26000
Residual Income= Net Operating income-(Minimum Required return on assets*Average Operating Assets)
=244000-(2300000*0.12)
=(32000)
(II) (c)
1). Return on investment= (Total Operating income/Average assets)*100
=244000/(2300000+440000)*100
=8.91%
Residual Income= Net Operating income-(Minimum Required return on assets*Average Operating Assets)
=232000-(2740000*0.12)= -96800
(II) (d)
-182000
Note:
Residual Income= Net Operating income-(Minimum Required return on assets*Average Operating Assets)
=232000-(2300000*0.18)
=-182000
Return on investment 10.09% Investment Turnover 780000 Profit Margin 35% Residual Income-44000
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