Financial data for Redstone Company for last year appear below Redstone Company

Question

Financial data for Redstone Company for last year appear below Redstone Company Statements of Financial Position Beginning Balance Ending Balance Assets: Cash Accounts receivable Inventory Plant and equipment (net) Investment in Balsam Company Land (undeveloped) $ 288,000 $ 189,663 191,000 286,000 450,000 262,000 458,000 126,000 264,000 442,000 243,000 458,000 Total assets $1,821,000 $1,836,663 Liabilities and owners' equity Accounts payable Long-term debt Owners' equity $ 252,000 223,000 841,000 772,663 841,000 728,000 Total liabilities and owners' equity $1,821,000 $1,836,663

Explanation / Answer

Redstone Company

Margin –

Margin = (net operating income/sales) x100

Net operating income = $438,900

Sales = $2,310,000

Margin = ($438,900/$2,310,000) x 100 =19%

Hence, margin =19%

Turnover –

Turnover = sales/average operating assets

Sales = $2,310,000

operating assets include,

Cash + Accounts Receivable + Inventory + Plant and Equipment (net)

Beginning balance total = $288,000 + $126,000 + $264,000 + $442,000 = $1,120,000

Ending balance total = $189,663 + $191,000 + $286,000 + $450,000 = $1,116,663

Average operating assets = (beginning balance + ending balance)/2

                        = (1,120,000 + 1,116,663)/2

Average operating assets = $1,118,332

Turnover = 2,310,000/1,118,332

Hence turnover = 2.07

Note: Operating assets do not include Investment in Balsam Company and undeveloped Land.

Return on Investment (ROI) –

Return on Investment = margin x turnover

Margin = 19%

Turnover = 2.07

ROI = 19% x 2.07 = 39.33%

Margin                                    19%

Turnover                                 2.07

Return on Investment             39.33%

Residual income = net operating income – return on average operating assets

Net operating income = $438,900

Minimum return on average operating assets = 35% of $1,118,332 = $391,416

Residual income = $438,900 - $391,416 =$47,484

Hence, residual income = $47,484

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