Solano Company has sales of $620,000, cost of goods sold of $430,000, other oper

ID: 2453806 • Letter: S

Question

Solano Company has sales of $620,000, cost of goods sold of $430,000, other operating expenses of 51,000, average invested assets of $1,900,000, and a hurdle rate of 10 percent.

Determine Solano’s return on investment (ROI), investment turnover, profit margin, and residual income. (Loss amounts should be indicated by a minus sign. Do not round your intermediate calculations. Round your "Investment Turnover" answer to 4 decimal places and "Return on Investment" answer to 1 decimal place and "Profit margin" answer to 2 decimal places.)

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.)

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.)

Operating expenses decrease by $15,500. (Loss amounts should be indicated by a minus sign. Do not round your intermediate calculations. Round your "Return on Investment" answer to 2 decimal places.)

Operating expenses increase by 10 percent. (Loss amounts should be indicated by a minus sign. Do not round your intermediate calculations. Round your "Return on Investment" answer to 2 decimal places.)

Average invested assets increase by $360,000. (Loss amounts should be indicated by a minus sign. Do not round your intermediate calculations. Round your "Return on Investment" answer to 2 decimal places.)

Solano changes its hurdle rate to 16 percent. (Loss amounts should be indicated by a minus sign. Do not round your intermediate calculations. Round your "Return on Investment" answer to 1decimal place.)

Solano Company has sales of $620,000, cost of goods sold of $430,000, other operating expenses of 51,000, average invested assets of $1,900,000, and a hurdle rate of 10 percent.

Explanation / Answer

Answer:

Basic Data for Calculation

Sales

$620,000

Cost of Goods Sold

$430,000

Other Operating Expenses

$51,000

Operating Profit (A-B-C)

$139,000

Gross Profit (Sales – COGS)

$190,000

Average invested assets

$1,900,000

Hurdle Rate

10%

Cost of Investment (Average Invested Assets x Hurdle Rate)

$1,900,000 x 10% = $190,000

1) Calculation of Return on investment (ROI), Investment turnover, profit margin, and residual income:

Return on Investment (ROI) = Operating Profit / Average Invested Assets x 100

ROI = $139,000 / $1,900,000 x 100 = 7.315 % or 7.32%

Profit Margin

Gross Profit Margin = Gross Profit / Sales x 100 = $190,000 / $620,000 x 100 = 30.645% or 30.65%

Net Profit Margin = Operating Profit / Sales x 100 = $139,000 / $620,000 x 100 = 22.419% or 22.42%

Residual Income = Operating Profit – Cost of Capital/Investment = $139,000 - $190,000 = -$51,000

Investment Turnover = Sales / Average Investment in Asset = $620,000 / $1,900,000 = 0.3263

2) Determination of each scenario’s impact on Solano’s ROI and Residual Income

a. Company sales and cost of goods sold increase by 30 percent

Revised Sales = $620,000 + ($620,000 x 30%) = $806,000

Revised Cost of Goods Sold = $430,000 + $430,000 x 30% = $559,000

Revised Operating Profit = Sales – COGS – Other Operating expenses = $806,000 - $559,000 - $51,000 = $196,000

New ROI = Operating Profit / Average Invested Assets x 100 = $196,000 / $1,900,000 x 100 = 10.32%

New Residual Income = Operating Profit – Cost of Capital/Investment = $196,000 - $190,000 = $6,000

b. Operating expenses decrease by $15,500

Revised Operating Profit = Sales – COGS – Other Operating expenses = $620,000 - $430,000 – ($51,000 - $15,500) = $154,500

New ROI = Operating Profit / Average Invested Assets x 100 = $154,500 / $1,900,000 x 100 = 8.13%

New Residual Income = Operating Profit – Cost of Capital/Investment = $154,500 - $190,000 = -$35,500

C. Operating expenses increase by 10 percent

Revised Operating Expenses = $51,000 + ($51,000 x 10%) = $56,100

Revised Operating Profit = Sales – COGS – Other Operating expenses = $620,000 - $430,000 – $56,100 = $133,900

New ROI = Operating Profit / Average Invested Assets x 100 = $133,900 / $1,900,000 x 100 = 7.05%

New Residual Income = Operating Profit – Cost of Capital/Investment = $133,900 - $190,000 = -$56,100

D. Average invested assets increase by $360,000.

Revised Average Invested Assets = $1,900,000 + $360,000 = $2,260,000

Cost of Capital = $2,260,000 x 10% = $226,000

New ROI = Operating Profit / Average Invested Assets x 100 = $139,000 / $2,260,000 x 100 = 6.15%

New Residual Income = Operating Profit – Cost of Capital/Investment = $139,000 - $226,000 = -$87,000

E. Solano changes its hurdle rate to 16 percent.

Revised Cost of Capital = $1,900,000 x 16% = $304,000

New ROI = Operating Profit / Average Invested Assets x 100 = $139,000 / $1,900,000 x 100 = 7.32%

New Residual Income = Operating Profit – Cost of Capital/Investment = $139,000 - $304,000 = -$165,000

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Summary of Existing and Change in ROI and Residual Income under each scenario’s

Scenario

New

ROI

Residual Income

Existing

7.32%

-$51,000

2a.

Company sales and cost of goods sold increase by 30 percent

10.32%

$6,000

2b.

Operating expenses decrease by $15,500

8.13%

-$35,500

2c.

Operating expenses increase by 10 percent

7.05%

-$56,100

2d.

Average invested assets increase by $360,000

6.15%

-$87,000

2e.

Solano changes its hurdle rate to 16 percent.