Question

Solano Company has sales of $740,000, cost of goods sold of $490,000, other operating expenses of $46,000, average invested assets of $2,200,000, and a hurdle rate of 10 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 $10,000.
c. Operating expenses increase by 10 percent.
d. Average invested assets increase by $420,000.
e. Solano changes its hurdle rate to 16 percent.

Answer 1

Basic Data 1 Sales 740000 2 Cost of goods sold 490000 3 other operating Expenses 46000 4 Operating Income(1-2-3) 204000 Return on investment= Operating Income Average invested assets 04000 2200000 9.27 % Residual Income= Operating Income-Average invested Assets Hurdle rate 1 = 204000-2200000*10 % -16000

Investment Turnover Net Sales 1 Average invested assets 740000 2200000 0.34 Operating Income Profit Margin= Net Sales 204000 740000 0.28

ROI And Residual Income 2a. Basic Data 1 Sales(740000+30%) 962000 2 Cost of goods sold(490000+30%) 3 other operating Expenses 637000 46000 4 Operating Income(1-2-3) 279000 Operating Income Return on investment= Average invested assets 279000 2200000 12.68 % Residual Income= Operating Income-Average invested Assets Hurdle rate = 279000-2200000*10% 59000

2b. ROI And Residual Income Basic Data 1 Sales 740000 2 Cost of goods sold 490000 3 other operating Expenses(46000-10000) 36000 4 Operating Income(1-2-3) 214000 Return on investment= Operating Income Average invested assets 214000 2200000 9.73 % Residual Income= Operating Income-Average invested Assets Hurdle rate = 214000-2200000*10 % -6000

ROI And Residual Income 2c. Basic Data 1 Sales 740000 2 Cost of goods sold 490000 3 other operating Expenses(46000+46000*10%) 50600 4 Operating Income(1-2-3) 199400 Return on investment Operating Income Average invested assets 199400 2200000 9.06 % Residual Income= Operating Income-Average invested Assets Hurdle rate = 199400-2200000*10 % -20600

ROI And Residual Income 2d. Basic Data 1 Sales 740000 2 Cost of goods sold 490000 3 other operating Expenses(46000) 46000 4 Operating Income(1-2-3) 204000 Return on investment Operating Income Average invested assets+420000 204000 2620000 7.79% Residual Income= Operating Income-Average invested Assets Hurdle rate = 204000-2620000 10% -58000

ROI And Residual Income 2e. Basic Data 1 Sales 740000 2 Cost of goods sold 490000 3 other operating Expenses 46000 4 Operating Income(1-2-3) 204000 Return on investment Operating Income Average invested assets 204000 2200000 9.27 % Residual Income= Operating Income-Average invested Assets Hurdle rate = 204000-2200000*16% -148000