Question

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

	River Division			Stream Division
Sales revenue	$	1,217,000		$	1,809,000
Cost of goods sold and operating expenses		888,000			1,289,000
Net operating income	$	329,000		$	520,000
Average invested assets	$	1,070,000		$	1,410,000
The company’s hurdle rate is 7.76 percent. 1. 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%.)) 2. Recalculate ROI and residual income for each division for each independent situation that follows: (Enter your ROI answers as a percentage rounded to two decimal places, (i.e., 0.1234 should be entered as 12.34%.)) a. Operating income increases by 10 percent. b. Operating income decreases by 9 percent c. The company invests $247,000 in each division, an amount that generates $103,000 additional income per division. d. Coolbrook changes its hurdle rate to 5.76 percent.

Answer 1

1. ROI

River Division = Net operating income / Average Invested Assets

= 329000 / 1070000

= 30.75%

Residual income = Net operating income - ( Average Invested Assets * hurdle rate )

= 329000 - ( 1070000 * 7.76%)

= $245968

Stream Division = Net operating income / Average Invested Assets

= 520000 / 1410000

= 36.88%

Residual income = Net operating income - ( Average Invested Assets * hurdle rate )

= 520000 - ( 1410000 * 7.76%)

= $410584

2. a Operating income increases by 10%

River Division = Net operating income / Average Invested Assets

= 329000*110% / 1070000

= 33.82%

Residual income = Net operating income - ( Average Invested Assets * hurdle rate )

= 361900 - ( 1070000 * 7.76%)

= $278868

Stream Division = Net operating income / Average Invested Assets

= 520000*110% / 1410000

= 40.57%

Residual income = Net operating income - ( Average Invested Assets * hurdle rate )

= 572000 - ( 1410000 * 7.76%)

= $462584

b. Operating income decreases by 9%

River Division = Net operating income / Average Invested Assets

= 329000*91% / 1070000

= 27.98%

Residual income = Net operating income - ( Average Invested Assets * hurdle rate )

= 299390 - ( 1070000 * 7.76%)

= $216358

Stream Division = Net operating income / Average Invested Assets

= 520000*91% / 1410000

= 33.56%

Residual income = Net operating income - ( Average Invested Assets * hurdle rate )

= 473200 - ( 1410000 * 7.76%)

= $363784

c. Invests additional $247000 and income generated $103000

River Division = Net operating income / Average Invested Assets

= 329000+103000 / 1070000+247000

= 34.45%

Residual income = Net operating income - ( Average Invested Assets * hurdle rate )

= 432000 - ( 1254000 * 7.76%)

= $334690 Approx

Stream Division = Net operating income / Average Invested Assets

= 520000+103000 / 1410000+247000

= 37.6%

Residual income = Net operating income - ( Average Invested Assets * hurdle rate )

= 623000 - ( 1657000 * 7.76%)

= $494417

d. Coolbrook Changes hurdle rate to 5.76%

River Division = Net operating income / Average Invested Assets

= 329000 / 1070000

= 30.75%

Residual income = Net operating income - ( Average Invested Assets * hurdle rate )

= 329000 - ( 1070000 * 5.76%)

= $267368

Stream Division = Net operating income / Average Invested Assets

= 520000 / 1410000

= 36.88%

Residual income = Net operating income - ( Average Invested Assets * hurdle rate )

= 520000 - ( 1410000 * 5.76%)

= $438784