Question

Kaler Company has sales of $1,410,000, cost of goods sold of $785,000, other operating expenses of $198,000, average invested assets of $4,400,000, and a hurdle rate of 11 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.)

Please calculate step-by-step

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 5 percent.

b. Operating expenses increase by $83,000.

c. Operating expenses decrease by 10 percent.

d. Average invested assets decrease by $385,000.

e. Kaler changes its hurdle rate to 8 percent.

Answer 1

Solution:

Given that Sales = $1,410,000, Cost of goods sold = $785,000, Other operating expenses = $198,000, Average invested assets = $4,400,000 and Hurdle rate = 11%

1. Net Income = Sales - Cost of goods sold - Other operating expenses

Net Income = $1,410,000 - $785,000 - $198,000

Net Income = $427,000

ROI = Net Income/Average invested assets

ROI = $427,000/$4,400,000

ROI = 9.70%

Investment turnover = Sales/ Average invested assets

Investment turnover = $1,410,000/ $4,400,000

Investment turnover = 32.05%

Profit margin = Net Income/Sales

Profit margin = $427,000/$1,410,000

Profit margin = 30.28%

Residual income = Net Income - Charge for Capital used

Residual income = $427,000 - 4,400,000 x 0.11

Residual income = -$57,000

2.

a.  Company sales and cost of goods sold increase by 5 percent.

Sales = $1,410,000 x 1.05 = $1,480,500

Cost of goods sold = $785,000 x 1.05 = $824,250

Net Income = Sales - Cost of goods sold - Other operating expenses

Net Income = $1,480,500 - $824,250 - $198,000

Net Income = $458,250

ROI = Net Income/Average invested assets

ROI = $458,250/$4,400,000

ROI = 10.41%

Residual income = Net Income - Charge for Capital used

Residual income = $458,250 - 4,400,000 x 0.11

Residual income = -$25,750

b. Operating expenses increase by $83,000.

Operating expenses = $198,000 + $83,000 = $281,000

Net Income = Sales - Cost of goods sold - Other operating expenses

Net Income = $1,410,000 - $785,000 - $281,000

Net Income = $344,000

ROI = Net Income/Average invested assets

ROI = $344,000/$4,400,000

ROI = 7.82%

Residual income = Net Income - Charge for Capital used

Residual income = $344,000 - 4,400,000 x 0.11

Residual income = -$140,000

c.  Operating expenses decrease by 10 percent.

Operating expense = 198,000 x (1 - 0.10) = 178,200

Net Income = Sales - Cost of goods sold - Other operating expenses

Net Income = $1,410,000 - $785,000 - $178,200

Net Income = $446,800

ROI = Net Income/Average invested assets

ROI = $446,800/$4,400,000

ROI = 10.15%

Residual income = Net Income - Charge for Capital used

Residual income = $446,800 - 4,400,000 x 0.11

Residual income = -$37,200

d. Average invested assets decrease by $385,000

Average invested assets = $4,400,000 - $385,000 = $4,015,000

Net Income = Sales - Cost of goods sold - Other operating expenses

Net Income = $1,410,000 - $785,000 - $198,000

Net Income = $427,000

ROI = Net Income/Average invested assets

ROI = $427,000/$4,015,000

ROI = 10.64%

Residual income = Net Income - Charge for Capital used

Residual income = $427,000 - 4,015,000 x 0.11

Residual income = -$14,650

e. Kaler changes its hurdle rate to 8 percent.

Net Income = Sales - Cost of goods sold - Other operating expenses

Net Income = $1,410,000 - $785,000 - $198,000

Net Income = $427,000

ROI = Net Income/Average invested assets

ROI = $427,000/$4,400,000

ROI = 9.70%

Residual income = Net Income - Charge for Capital used

Residual income = $427,000 - 4,400,000 x 0.08

Residual income = $75,000