Question

Coolbrook Company has the following information available for the past year:   

	River Division			Stream Division
Sales revenue	$	1,208,000		$	1,812,000
Cost of goods sold and operating expenses		893,000			1,286,000
Net operating income	$	315,000		$	526,000
Average invested assets	$	1,190,000		$	1,530,000

The company’s hurdle rate is 7.01 percent.
Required:

1. Calculate return on investment (ROI) and residual income for each division for last year.

2. Recalculate ROI and residual income for the division for each independent situation that follows:

a. Operating income increases by 11 percent.

b. Operating income decreases by 9 percent.

c. The company invests $246,000 in each division, an amount that generates $104,000 additional income per division.

d. Coolbrook changes its hurdle rate to 5.01 percent.

Calculate return on investment (ROI) and residual income for each division for last year. (Enter your ROI answers as a percentage rounded to two decimal places, (i.e., 0.1234 should be entered as 12.34%.))

River Division Stream Division ROI %    % Residual Income (Loss)

Answer 1

			River Division			Stem Division
1)	ROI = Net Operating income / Average Investment * 100
		ROI = 315,000 / 1,190,000 * 100		ROI = 526,000 / 1530000* 100
		ROI = 26.47 %			ROI = 34.38 %
		Residual Value = Net operating income - ( Average Investments* Hurdle Rate)
		Residual Income = 315000 - ( 1190000 * 7.01 %)	Residual Income = 526,000 - ( 1,530,000 * 7.01 %)
		Residual Income = 315000 - 83419		Residual Income = 526,000 - 107253
		Residual Income = 231581		Residual Income = 418747

2) a)		Operating Income Increase by 11 %
		New operating Income = 349650 ( 315000 + 11 %)	New Operating Income = 583860 ( 526000 + 11% )
		ROI = 315000 / 1190000 * 100		ROI = 583860 / 1530000* 100
		ROI = 29.38 %			ROI = 38.16 %
		Residual Income = 349650 - ( 1190000 * 7.01 %)	Residual Income = 583860 - ( 1,530,000 * 7.01 %)
		Residual Income = 349650 - 83419		Residual Income = 583860 - 107253
		Residual Income = 266231		Residual Income = 476607
2 b)		Operating Income Decrease by 9 %
		New operating Income = 286650- (315000- 9 %)	New operating income = 478660- (526000 - 9%)
		ROI =   286650 / 1,190,000 * 100		ROI = 478660 / 1530000* 100
		ROI = 24.09 %			ROI = 31.28 %

		Residual Income =286650 - ( 1190000 * 7.01 %)	Residual Income = 478660 - ( 1,530,000 * 7.01 %)
		Residual Income = 286650 - 83419		Residual Income =478660 - 107253
		Residual Income = 203231		Residual Income = 371407
2 (c )		New average investment = 1436000 ( 1190000 + 246000)	New average investment = 1776000 ( 1,530,000 + 246000)
		New Net operating income = 419000 ( 315000 + 104000	New Net operating Income = 630000 ( 526,000 + 104000)
		ROI = 419000 / 1436000 * 100		ROI = 630000 / 1776000 * 1000
		ROI = 29.18 %			ROI = 35.47 %
		Residual Income = 419000 - ( 1436000 * 7.01 % )	Residual Income = 630000 - (1776000 * 7.01 %)
		Residual Income = 419000- 100664		Residual Income = 505502
		Residual Income = 318336
2(d)		Change in Hurdle Rate =5.01 %
		Residual Income =315000 - ( 1190000 * 5.01 %)	Residual Income = 478660 - ( 1,530,000 * 5.01 %)
		Residual Income = 315000 -59619		Residual Income= 526000 - 76653
		Residaul Income = 255381		Residual Income = 449347