Question

OPEN THE IMAGE IN A NEW TAB, SORRY i AM HAVING TROUBLE WITH THE RESOLUTION

40D points PA10-2 Calculating Unknowns, Predicting Relationship among Return on Investment, Residual Income, Hurdle Rates LO 10-4,10-5 T e o cwing is partial information or chareston company's most recent year o↑cperaion it manufactures lawn mowers and categorizes is operations no t o disons er ruda and Mdfen. crmuda Midiron Average invested assets Nct Operating income Prott margh Inmeatment tumove Relurn on irnestment Residual ncoms 600,000 S 160,000 150,000 0.16 $ 40,000 30,000) 52,500,000 The Bemude Diviin tuon inveslment Cherleston's urde rate The Micion Divisin'sreturnm on investment is Charleston's hurde rate 2. Determine the missing amounts in the preceding table. (Round your Rol percentage answers to 1 decimal place.(ie.. 0.123 should be entered as 12.3%). Round investment tumover to 2 decimal places.) Sales rasnus 7,5 DD Neloperating income Proft margin hves mentturnover Return on hvattmant 5 150,00D 5 150,000 20% 0.16 3. What is Chantston's hurdle rate? [Round your answer to 1 dacimi place, {Le, 0.123 should ba enterad as 12.3%.)) 4-. Suppose Charleston has the oppertunity to invest aditional assets to hep expand the company's market share. The expansion wculd require an average inveetment of S2,0c0 000 and would generate $140 000 in adcitional icome. Calculate the return on investment of the proposec expansion. Nc he Micion Divisi

Answer 1

Solution

Charleston Company

1. Without making any calculations…

Bermuda Division's Return on Investment is	HIGHER than	Charleston Hurdle Rate
Midiron Division's Return on Investment is	LOWER than	Charleston Hurdle Rate

Bermuda division reports positive residual income of $40,000. This indicates that the division’s return on investment (ROI) is higher than the company’s hurdle rate.

Residual income = net income – hurdle rate x average invested assets

Midiron division reports negative residual income of $30,000. This indicates that the division’s ROI is lower than the company’s hurdle rate.

1. Determination of missing amounts:

	Bermuda Division	Midiron Division
Sales Revenue	$800,000	$600,000
Average Invested Assets	2,500,000	$3,750,000
Net Operating Income	$160,000	$150,000
Profit Margin	20%	25%
Investment Turnover	0.32	0.16
Return on Investment	6.40%	4%
Residual Income	$40,000	($30,000)

	Computations:
1	sales revenue of Bermuda division	net operating income/profit margin	160,000/20%	$800,000
2	Average invested assets of Midiron division	sales/investment turnover	600,000/0.16	$3,750,000
3	Profit margin of Midiron Div	net operating income/sales revenue	150,000/600,000	25%
4	Investment turnover of Bermuda	sales/average invested assets	800,000/2,500,000	0.32
5	ROI of Bermuda div.	margin x investment turnover	20% x 0.32	6.40%
6	ROI of Midiron div.	margin x investment turnover	25% x 0.16	4%

1. Determination of the company’s hurdle rate –

Residual income = net operating income – hurdle rate x average invested assets

Burmuda div. residual income = $40,000

$40,000 = 160,000 – (hurdle rate x 2,500,000)

Hurdle rate x 2,500,000 = 160,000 – 40,000 = $120,000

Hurdle rate = 110,000/2,500,000 = 4.8%

Midiron div. residual income = ($30,000)

-$30,000 = 150,000 – (hurdle rate x 3,750,000)

Hurdle rate x 3,750,000 = 150,000 + 30,000 = $180,000

Hurdle rate = 180,000/3,750,000 = 4.8%

1. A.

ROI on additional investment –

Average investment = $2,800,000

Additional income = $140,000

ROI on proposed expansion = 140,000/2,800,000 = 5%

4 B.Yes, from Charleston perspective the expansion project is a viable investment.

Explanation: The ROI of expansion project, 5% is higher than Charleston’s hurdle rate of 4.8%. Hence, a viable investment.

1. Which division would think as viable investment –

Midiron Division's Return on Investment is	Viable	the investment
Bermuda Division	Not Viable	the investment

Explanation:

Midiron division would think the investment as viable as the ROI (5%) of the expansion project is higher than the division’s ROI (4%).

Bermuda division would think the investment as not viable as the ROI (5%) of the expansion project is lower than the division’s ROI (6.4%).