Question

Solano Company has sales of $580,000, cost of goods sold of $410,000, other operating expenses of $54,000, average invested assets of $1,800,000, and a hurdle rate of 9 percent.
Required:
1. Determine Solano’s return on investment (ROI), investment turnover, profit margin, and residual income.
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.)
a. Company sales and cost of goods sold increase by 30 percent.
b. Operating expenses decrease by $13,500.
c. Operating expenses increase by 10 percent.
d. Average invested assets increase by $340,000.
e. Solano changes its hurdle rate to 15 percent.

Answer 1

Answer:

1.

ROI=6.44%

Investment Turnover=0.32

Profit Margin=20%

Residual Income (RI) = -$46,000

2.

a) ROI =9.28%, RI= $5,000

b) ROI=7.19%, RI= -$32,500

c) ROI=6.15%, RI= -$51,400

d) ROI=5.4%, RI= -$76,600

e) ROI=6.44%, RI= -$154,000

Explanation:

1. ROI is calculated as (Operating profit/Average net asset/Investment)*100.

Investment turnover is calculated as Net sales/Average net asset/Investment.

Profit Margin is calculated as Operating profit/Total sales.

Residual Income is calculated as Operating profit-(Average net asset/Investment * Hurdle rate).

Note: Operating profit= Sales-(Cost of goods sold+Operating expenses)

2.

a) 30% increase in sales & cost of goods sold will increase the ROI & Residual income.

b) Decrease in operating expense will increase the operating income, thereby increasing the ROI & RI.

c) Increase in operating expense by 10% will reduce the operating income, thereby decreasing the ROI & RI.

d) Increase in average invested assets by $340,000 will reduce the ROI & RI.

e) Change in hurdle rate will not change the ROI; however, it will decrease the residual income (RI).