Question

Zear Company produces an electronic processor and sells it wholesale to manufacturing and retail outlets at $10 each. In Zear"s Year 8 fiscal period, it sold 700,000 processors. Fixed costs for Year 8 total $1,500,000, including interest costs on its 7.5% debentures. Variable costs are $4 per processor for materials. Zear employs about 20 hourly paid plant employees, each earning $35,000 in Year 8. Zear is currently confronting labor negotiations. The plant employees are requesting substantial increases in hourly wages. Zear forecasts a 7.5% increase in fixed costs and no change in either the processor"s price or in material costs for the processors. Zear also forecasts a 10% growth in sales volume for Year 9. To meet the necessary increase in production due to sales demand, Zear recently hired two additional hourly plant employees. The condensed balance sheet for Zear at the end of fiscal Year 8 follows (the tax rate is 50%):

Assets		Liabilities and equity
Current assets		Current liabilities	$2,000,000
Cash	$ 700,000	Long-term 71/2% debenture	2,000,000
Receivables	1,000,000	6% preferred stock, 10,000
Other	800,000	shares, $100 par value	1,000,000
Total current assets	2,500,000	Common stock	1,800,000
Fixed assets (net)	5,500,000	Retained earnings	1,200,000
Total assets	$8,000,000	Total liabilities and equity	$8,000,000

Required:

a. Compute Zear"s return on invested capital for Year 8 where invested capital is:

(1) Net operating assets at end of Year 8 (assume all assets and current liabilities are operating).

(2) Common equity capital at end of Year 8.

b. Calculate the maximum annual wage increase Zear can pay each plant employee and show a 10% return on net

operating assets.

Answer 1