Question

E10-5 Calculating Return on Investment, Residual Income, Determining Effect of Changes in Sales, Expenses, Invested Assets, Hurdle Rate on Each [LO 10-4, 10-5]

Solano Company has sales of $780,000, cost of goods sold of $510,000, other operating expenses of $38,000, average invested assets of $2,300,000, and a hurdle rate of 12 percent.


Required:
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.)

	Return on Investment % Investment Turnover Profit Margin % Residual Income (Loss)

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 30 percent.      

        

	Return on Investment % Residual Income (Loss)

  b. Operating expenses decrease by $12,000.        
      
        

	Return on Investment % Residual Income (Loss)

c. Operating expenses increase by 10 percent.

       

	Return on Investment % Residual Income (Loss)

  d. Average invested assets increase by $440,000.

	Return on Investment % Residual Income (Loss)

  e. Solano changes its hurdle rate to 18 percent.

Return on Investment		%
Residual Income (Loss)

Answer 1

(I)

1). Return on investment= (Total Operating income/Average assets)*100

=(232000/2300000)*100= 10.09%

2) Total Operating income= Sales-COGS-Operating Exp

=780000-510000-38000

=232000

3) profit margin=(Sales-COGS)/Sales

=(780000-510000)/780000

=35%

3) Residual Income= Net Operating income-(Minimum Required return on assets*Average Operating Assets)

=232000-(2300000*0.12)

Return on investment	10.09%
Investment Turnover	780000
Profit Margin	35%
Residual Income	-44000

(II)

(a) 30% Increase in sales and cost of goods sold

Return on Investment	13.61%
Residual income	37000

1). Return on investment= (Total Operating income/Average assets)*100

=(313000/2300000)*100= 13.61%

Total Operating income= Sales-COGS-Operating Exp

Sales 780000*130% 1014000

CoGS =510000*130% 663000

Operating cost 38000

Net Op. Income 313000

Residual Income= Net Operating income-(Minimum Required return on assets*Average Operating Assets)

=313000-(2300000*0.12) =37000

(II) (b)

Operaing Expense decrease by $12000

return on Investment	10.61%
Residual income	(-32000)

Note:

1). Return on investment= (Total Operating income/Average assets)*100

=244000/2300000*100

=10.61%

Total Operating income= Sales-COGS-Operating Exp

=780000-510000-26000

Residual Income= Net Operating income-(Minimum Required return on assets*Average Operating Assets)

=244000-(2300000*0.12)

=(32000)

(II) (c)

Average Invested assets increase by $440000
return on Investment	8.91%
Residual income	-96800

1). Return on investment= (Total Operating income/Average assets)*100

=244000/(2300000+440000)*100

=8.91%

Residual Income= Net Operating income-(Minimum Required return on assets*Average Operating Assets)

=232000-(2740000*0.12)= -96800

(II) (d)

Change in hurdle rate to 18%
return on Investment	10.09%
Residual income	-182000

Note:

Residual Income= Net Operating income-(Minimum Required return on assets*Average Operating Assets)

=232000-(2300000*0.18)

=-182000