Solano Company has sales of $500,000, cost of goods sold of $370,000, other oper

Question

Solano Company has sales of $500,000, cost of goods sold of $370,000, other operating expenses of $50,000, average invested assets of $1,600,000, and a hurdle rate of 6 percent. 1. Determine Solano's return on investment (ROI), investment turnover, profit margin, and residual income. Loss amount should be indicated by a minus sign. Do not round your intermediate calculations. Round your "Investment Turnover" answer to 4 decimal places.) Return on Investment Investment Turnover Profit Margin Residual Income 1% 2. Several possible changes that Solano could face in the upcoming year follow. Determine each scenario's impact on Solano's ROl and residual income. (Note: Treat each scenario independently.) a. Company sales and cost of goods sold increase by 30 percent. (Do not round your intermediate calculations. Round your "Return on Investment" answer to 2 decimal places.) Return on Investment Residual Income b. Operating expenses decrease by $10,000. (Loss amount should be indicated by a minus sign. Do not round your intermediate calculations. Round your "Return on Investment" answer to 2 decimal places.) Return on Investment Residual Income

Explanation / Answer

Sales 500000 COGS 370000 Other operating exp. 50000 Avg.Invested Assets 1600000 Hurdle rate = Cost of capital = 6% Answer 1 Operating income = sales - COGS - Other operating cost Operating income = $80000 Cost of capital = 1600000 * 6% = $96000 Net Income = Operating Income - Cost of capital = -$16000 Return on investment = Net Income / Avg Invested assets = -16000 / 1600000 = -1% Investment Turnover ratio = Turnover / Avg.Invested assets = 500000 / 1600000 = 0.003125 Profit Margin = Profit / Sales = -16000 / 500000 = -0.032 Residual Income = -$16000 Answer 2 A) Sales 650000 COGS 481000 Net Income = 650000 - 481000 - 50000 - 96000 = $23000 Return on investment = Net Income / Avg Invested assets = 23000 / 1600000 = 1.44% Residual Income = $23000 B) Other operating exp. 40000 Net Income = 500000 - 370000 - 40000 -96000 = -$6000 Return on investment = Net Income / Avg Invested assets = -6000 / 1600000 = -0.38% Residual Income = -$6000 C) Other operating exp. 60000 Net Income = 500000 - 370000 - 60000 -96000 = -$26000 Return on investment = Net Income / Avg Invested assets = -26000 / 1600000 = -1.63% Residual Income = -$26000 D) Avg.Invested Assets 1900000 Cost of capital = 1900000 * 6% = $114000 Net Income = Operating Income - Cost of capital = 80000 - 114000 = -$34000 Return on investment = Net Income / Avg Invested assets = -34000 / 1900000 = -1.79% Residual Income = -$34000 E) Hurdle rate = Cost of capital = 12% Cost of capital = 1600000 * 12% = $192000 Net Income = Operating Income - Cost of capital = -$112000 Return on investment = Net Income / Avg Invested assets = -112000 / 1600000 = -7% Residual Income = -$112000

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