Question

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

	River Division			Stream Division
Sales revenue	$	1,201,000		$	1,801,000
Cost of goods sold and operating expenses		894,000			1,280,000
Net operating income	$	307,000		$	521,000
Average invested assets	$	1,090,000		$	1,520,000

   
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. (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 11 percent.



b. Operating income decreases by 12 percent.



c. The company invests $243,000 in each division, an amount that generates $106,000 additional income per division.



d. Coolbrook changes its hurdle rate to 5.01 percent.

Answer 1

• All working forms part of the answer
• Requirement 1

Working		River Division	Stream Division
A	Net Operating Income	$              3,07,000.00	$             5,21,000.00
B	Average invested Assets	$           10,90,000.00	$           15,20,000.00
C=A/B	ROI	28.17%	34.28%
D	Hurdle rate	7.01%	7.01%
E=B x D	Hurdle Income	$                 76,409.00	$             1,06,552.00
F=A - E	Residual Income	$              2,30,591.00	$             4,14,448.00

• Requirement 2

Answer ‘a’

Working		River Division	Stream Division
A	Net Operating Income	$              3,40,770.00	$             5,78,310.00
B	Average invested Assets	$           10,90,000.00	$           15,20,000.00
C=A/B	ROI	31.26%	38.05%
D	Hurdle rate	7.01%	7.01%
E=B x D	Hurdle Income	$                 76,409.00	$             1,06,552.00
F=A - E	Residual Income	$              2,64,361.00	$             4,71,758.00

Answer ‘b’

Working		River Division	Stream Division
A	Net Operating Income	$              2,70,160.00	$             4,58,480.00
B	Average invested Assets	$           10,90,000.00	$           15,20,000.00
C=A/B	ROI	24.79%	30.16%
D	Hurdle rate	7.01%	7.01%
E=B x D	Hurdle Income	$                 76,409.00	$             1,06,552.00
F=A - E	Residual Income	$              1,93,751.00	$             3,51,928.00

Answer ‘c’

Working		River Division	Stream Division
A	Net Operating Income	$              4,13,000.00	$             6,27,000.00
B	Average invested Assets	$           13,33,000.00	$           17,63,000.00
C=A/B	ROI	30.98%	35.56%
D	Hurdle rate	7.01%	7.01%
E=B x D	Hurdle Income	$                 93,443.30	$             1,23,586.30
F=A - E	Residual Income	$              3,19,556.70	$             5,03,413.70

Answer ‘d’

Working		River Division	Stream Division
A	Net Operating Income	$              3,07,000.00	$             5,21,000.00
B	Average invested Assets	$           10,90,000.00	$           15,20,000.00
C=A/B	ROI	28.17%	34.28%
D	Hurdle rate	5.01%	5.01%
E=B x D	Hurdle Income	$                 54,609.00	$                 76,152.00
F=A - E	Residual Income	$              2,52,391.00	$             4,44,848.00