E10-6 Calculating Return on Investment, Residual Income, Determining Effect of C
ID: 2559764 • Letter: E
Question
E10-6 Calculating Return on Investment, Residual Income, Determining Effect of Changes in Sales, Expenses, Invested Asset, Hurdle Rate on Each [LO 10-4, 10-5]
Kaler Company has sales of $1,330,000, cost of goods sold of $765,000, other operating expenses of $178,000, average invested assets of $4,000,000, and a hurdle rate of 12 percent.
Required:
1. Determine Kaler’s return on investment (ROI), investment turnover, profit margin, and residual income. (Do not round your intermediate calculations. Enter your ROI and Profit Margin answer to the nearest whole percentage, (i.e., 0.1234 should be entered as 12%). Round your Investment Turnover answers to 4 decimal places.)
2. Several possible changes that Kaler could face in the upcoming year follow. Determine each scenario’s impact on Kaler’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 15 percent.
b. Operating expenses increase by $79,000.
c. Operating expenses decrease by 10 percent.
d. Average invested assets decrease by $345,000.
e. Kaler changes its hurdle rate to 9 percent.
Explanation / Answer
ROI = Net operating Income / Average invested assets
Residual Income = Net operating Income - ( Average invested assets * hurdle rate)
Answer 1
Net operating Income = Sales - cost of goods sold - other operating expenses
= $1,330,000 - $765,000 - $178,000 = $387,000
ROI = $387,000 / $4,000,000 = 9.675 %
Residual Income = $387,000 - ($4,000,000 * 12 %) = ($93,000)
Answer 2 a ) Company sales and cost of goods sold increase by 15 percent.
New Net operating Income = $387,000 + [ ($1,330,000 - $765,000 ) * 15 %] = $471,750
New ROI = $471,750 / $4,000,000 = 11.79 %
New Residual Income = $471,750 - ($4,000,000 * 12 %) = ($8,250)
Answe 2 b)
Operating expenses increase by $79,000
New Net operating Income = $387,000 - $79,000 = $308,000
New ROI = $308,000 / $4,000,000 =7.70%
New Residual Income = $308,000 - ($4,000,000 * 12 %) = ($172,000)
Answe 2 c)
Operating expenses decrease by 10 percent.
New Net operating Income = $387,000 +( $178,000 * 10 %) = $404,800
New ROI = $404,800 / $4,000,000 =10.12%
New Residual Income =$404,800 - ($4,000,000 * 12 %) = ($75,200)
Answe 2 d)
Average invested assets decrease by $345,000
New ROI =$387,000 / ($4,000,000 - $345,000) = 10.59%
New Residual Income =$387,000 - ($3,655,000 * 12 %) = ($51,600)
Answe 2 e)
Kaler changes its hurdle rate to 9 percent.
New ROI = $387,000 / $4,000,000 = 9.675 %(remain same as answer 1)
New Residual Income =$387,000 - ( $4,000,000 * 9 %) = $27,000
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