Question

Kaler Company has sales of $1,590,000, cost of goods sold of $830,000, other operating expenses of $243,000, average invested assets of $5,300,000, and a hurdle rate of 11 percent.

Required:
1. Determine Kaler’s return on investment (ROI), investment turnover, profit margin, and residual income. (Do not round your intermediate calculations. Enter your ROI and Profit Margin answer to the nearest whole percentage, (i.e., 0.1234 should be entered as 12%). Round your Investment Turnover answers to 4 decimal places.)



2. Several possible changes that Kaler could face in the upcoming year follow. Determine each scenario’s impact on Kaler’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 5 percent.



b. Operating expenses increase by $92,000.



c. Operating expenses decrease by 10 percent.



d. Average invested assets decrease by $475,000.



e. Kaler changes its hurdle rate to 8 percent.

Answer 1

1	Return on Investment = Net Operating Income / Average Investment Assets
	= $ 517,000 / $ 5,300,000
	= 10%
	Investment Turnover = Sales Revenue / Average Invested Assets
	Sales Revenue = $ 1,590,000
	Average Invested Assets = $ 5,300,000
	Investment Turnover = $ 1,590,000 / $ 5,300,000
	= 0.3
	Profit Margin = Net Operating Income / Sales Revenue
	Net Operating Income = Sales - Cost of Goods sold - Net operating expenses
		= $ 1,590,000 - $ 830,000 - $ 243,000
		= $ 517,000
	Profit Margin = $ 517,000 / $ 1,590,000
	= 33%
	Residual Income = Net Operating Income - ( Average Investment Asset * Hurdle Rate )
		= $ 517,000 - ( $ 5,300,000 * 11% )
		= $ 517,000 - $ 583,000
		= $ ( 66,000 )
2
a	Increase in sales and cost of goods sold by 5 %
	New Sales = $ 1,590,000 * 105%
		= $ 1,669,500
	New Cost of goods sold = $ 830,000 * 105%
		= $ 871,500
	Return on Investment = Net Operating Income / Average Investment Assets
	Net Operating Income = $ 1,669,500 - $ 871,500 - $ 243,000
		= $ 555,000
	Return on Investment = $ 550,000 / $ 5,300,000	= 10.38 %
	Residual Income = Net Operating Income - ( Average Investment Asset * Hurdle Rate )
		= $ 550,000 - $ 583,000
		= $ ( 33,000 )
b	New Operating expenses = $ 243,000 + $ 92,000
	= $ 335,000
	Net Operating Income = Sales - Cost of Goods sold - Net operating expenses
		= $ 1,590,000 - $ 830,000 - $ 335,000
		= $ 425,000
	Return on Investment = $ 425,000 / $ 5,300,000	= 8.02 %
	Residual Income = Net Operating Income - ( Average Investment Asset * Hurdle Rate )
	= $ 425,000 - $ 583,000
	= $ ( 158,000 )
c	New Operating expenses = $ 243,000 - $ 24,300
	= $ 218,700
	Net Operating Income = Sales - Cost of Goods sold - Net operating expenses
	= $ 1,590,000 - $ 830,000 - $ 218,700
	= $ 541,300
	Return on Investment = $ 541,300 / $ 5,300,000	= 10.21%
	Residual Income = Net Operating Income - ( Average Investment Asset * Hurdle Rate )
	= $ 541,300 - $ 583,000
	= $ ( 41,700 )
d	New average Invested Asset = $ 5,300,000 - $ 475,000
	= $ 4,825,000
	Return on Investment = $ 517,000 / $ 4,825,000	= 10.72%
	Residual Income = Net Operating Income - ( Average Investment Asset * Hurdle Rate )
	= $ 517,000 - ( 4,825,000 * 11 % )
	= $ 517,000 - $ 530,750
	= $ ( 13,750 )
e	Return on Investment = Net Operating Income / Average Investment Assets
	= $ 517,000 / $ 5,300,000
	= 9.75%
	Residual Income = Net Operating Income - ( Average Investment Asset * Hurdle Rate )
		= $ 517,000 - ( $ 5,300,000 * 8% )
		= $ 517,000 - $ 424,000
		= $ 93,000