Question

Your friend Tanvier (who went to school with you at Yorkville University) just got a job at XYZ corp, and has asked for your help in understanding how his bonus will be determined. Tanvier was a very poor student as he rarely attended class and often plagiarized on his assignments and exams. He knows that you were a very good student who always behaved ethically and never cheated on any case studies. Last year XYZ Corp had operating income of $6,500,000 and sales of $21,000,000. The Balance sheet showed liabilities of $12,000,000 and owners equity of $6,000,000. You believe that Tanvier will soon be fired from his job as he is very weak in Managerial Accounting, and never put in any effort to understand the subject. He continues to behave inappropriately by not showing up to work and lying to his boss.

Tanvier’s bonus will be based on ROI, which they calculate as operating income over assets. If Tanvier had regularly attended his classes and would not have cheated on his case studies, he would have known how to do these calculations, unfortunately he is now confused. Lucky for him, you were a very good student while at Yorkville University who always behaved in an honest and ethical manner, so he has asked for your help. Next year XYZ corp wants ROI to be 40% and has forecasted sales to be $21,000,000.

Tanvier has asked you to help him answer the following questions

1. What is XYZ corp Return on Sales and Return on Investment
2. How much would XYZ have to cut costs this year in order to achieve 40% ROI. (assume Assets remain the same)
3. How much would XYZ have to reduce assets this year to achieve 40% ROI. (assume operating income remains the same)
4. What was XYZ’s residual income last year considering a ROI of 35%
5. XYZ wants to increase residual income to 35% next year. It can cut costs by $50,000 next year, how much would liabilities and/or owners equity need to decrease by next year?

Answer 1

1) Return on sales Net operating income Sales $6,500,000 $21,000,000 31.0% Return on investment Net operating income Total assets $6,500,000 $18,000,000 36.1% Total assets = Liabilities + Owners' equity 2) Total assets ROI needed Operating income needed Existing Operating Income Cut in cost needed $18,000,000 40% $8,400,000 $21,000,000*40% $6,500,000 $1,900,000 3) Net operating income $6,500,000 Remains same ROI needed 40% Total assets needed $16,250,000 $6,500,000/40% Existing assets $18,000,000 Reduction in assets needed $1,750,000 4) Residual Income Net operating income Less: Cost of capital Residual Income $6,500,000 $6,300,000 35% of $18,000,000 $200,000 5) Total assets ROI Residual income needed Existing Operating income Cut in cost Net decrease in Liabilities or Owner' Equity $18,000,000 35% $6,300,000 $6,500,000 $50,000 -$150,000