Question

Solano Company has sales of $760,000, cost of goods sold of $500,000, other operating expenses of $40,000, average invested assets of $2,250,000, and a hurdle rate of 11 percent.

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 40 percent. (Find ROI and Residual income)

  b. Operating expenses decrease by $11,000.   (Find ROI and Residual income)

   c. Operating expenses increase by 20 percent. (Find ROI and Residual income)
  d. Average invested assets increase by $430,000. (Find ROI and Residual income)

  e. Solano changes its hurdle rate to 17 percent. (Find ROI and Residual income)

Answer 1

Operating income = Sales - COGS - operating Expenses

= 760000 - 500000 - 40000 = 220000

1. ROI = Net Operating income / Average Invested assets

= 220000/2250000*100

= 9.78%

Investment Turnover = sales/ investment = 760000/2250000 = .338

Profit margin is same as net operating income due to no taxes given

Residual Income = Net Operating income - ( Average Invested assets * hurdle rate )

= 220000 - (2250000*11%)

= $-27500

2 a.

Operating income = Sales - COGS - operating Expenses

= 760000*1.4 - 500000*1.4 - 40000 = 324000

ROI = Net Operating income / Average Invested assets

= 324000/2250000*100

= 14.4%

Residual Income = Net Operating income - ( Average Invested assets * hurdle rate )

= 324000 - (2250000*11%)

= $ 76500

b.

Operating income = Sales - COGS - operating Expenses

= 760000 - 500000 - (40000-11000) = 231000

ROI = Net Operating income / Average Invested assets

= 231000/2250000*100

= 10.27%

Residual Income = Net Operating income - ( Average Invested assets * hurdle rate )

= 231000 - (2250000*11%)

= $-16500

c.

Operating income = Sales - COGS - operating Expenses

= 760000 - 500000 - (40000*1.2) = 212000

ROI = Net Operating income / Average Invested assets

= 212000/2250000*100

= 9.42%

Residual Income = Net Operating income - ( Average Invested assets * hurdle rate )

= 212000 - (2250000*11%)

= $-35500

d.

Operating income = Sales - COGS - operating Expenses

= 760000 - 500000 - 40000 = 220000

ROI = Net Operating income / Average Invested assets

= 220000/(2250000+430000)*100

= 8.21%

Residual Income = Net Operating income - ( Average Invested assets * hurdle rate )

= 220000 - (2680000*11%)

= $-74800

e.

Operating income = Sales - COGS - operating Expenses

= 760000 - 500000 - 40000 = 220000

ROI = Net Operating income / Average Invested assets

= 220000/2250000*100

= 9.78%

Residual Income = Net Operating income - ( Average Invested assets * hurdle rate )

= 220000 - (2250000*17%)

= $-162500