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Question

• ? 18% DI Sun 5:58 PM Chrome File Edit View History Bookmarks People Window Help New Tab x D HW CH 10 - 0 ezto.mheducation.com/hm.tpx PA10-2 Calculating Unknowns, Predicting Relationship among Return on Investment, Residual Income, Hurdle Rates [LO 10-4, 10-5] OS YOSEF QAT € The following is partial information for Charleston Company's most recent year of operation. It manufactures lawn mowers and categorizes its operations into two divisions: Bermuda and Midiron. Bermuda Division ? $ 2,500,000 $ 180,000 Sales revenue Average invested assets Net Operating income Profit margin Investment turnover Return on investment Residual income Midiron Division S 600,000 $ 150,000 0.16 $ (30.000) 2094 $ 40,000 Required: 1. Without making any calculations, determine whether each division's return on investment is above or below Charleston's hurdle rate. The Bermuda Division's return on investment is The Midiron Division's return on investment is Charleston's hurdle rate Charleston's hurdle rate 2. Determine the missing amounts in the preceding table. (Round your ROI percentage answers to 1 decimal place, (i.e., 0.123 should be entered as 12.3%). Round investment turnover to 2 decimal places.) Bermuda Division Midiron Division $ 600,000 $2,500,000 $ 180,000 $ 150,000 Sales revenue Average invested assets Net operating income Profit margin Investment turnover Return on investment Residual income (Loss) 0.16 S 40,000 S (30,000)

Explanation / Answer

Answer to Part 1.

The Bermuda Division’s return on investments is above Charleston’s hurdle rate, as it has positive residual income.

The Midiron Division’s return on investments is below Charleston’s hurdle rate, as it has negative residual income.

Answer to Part 2.

Bermuda Division:

Profit Margin = Net Operating Income / Sales Revenue * 100
20 = 160,000 / Sales Revenue * 100
Sales Revenue = 160,000 * 100 / 20
Sales Revenue = $800,000

Investment Turnover = Sales / Average Invested Assets
Investment Turnover = 800,000 / 2,500,000
Investment Turnover = 0.32

Return on Investment = Profit Margin * Investment Turnover
Return on Investment = 20% * 0.32
Return on Investment = 6.4%

Midiron Division:

Profit Margin = Net Operating Income / Sales Revenue * 100
Profit Margin = 150,000 / 600,000 * 100
Profit Margin = 25%

Investment Turnover = Sales / Average Invested Assets
0.16 = 600,000 / Average Invested Assets
Average Invested Assets = $3,750,000

Return on Investment = Profit Margin * Investment Turnover
Return on Investment = 25% * 0.16
Return on Investment = 4%

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

6.4%

Residual Income

$40,000

$(30,000)

Answer to Part 3.

Bermuda Division:
Residual Income = Operating Income – (Average Invested Assets * Hurdle Rate)
$40,000 = $160,000 – ($2,500,000 * Hurdle Rate)
$2,500,000 * Hurdle Rate = $160,000 - $40,000
$2,500,000 * Hurdle Rate = $120,000
Hurdle Rate = 4.8%

Midiron Division:
Residual Income = Operating Income – (Average Invested Assets * Hurdle Rate)
Residual Income = Operating Income – (Average Invested Assets * Hurdle Rate)
$(30,000) = $150,000 – ($3,750,000 * Hurdle Rate)
$3,750,000 * Hurdle Rate = $150,000 + $30,000
$3,750,000 * Hurdle Rate = $180,000
Hurdle Rate = 4.8%

Answer to Part 4-a.

Return on Investment = Net Income / Average Investment* 100
Return on Investment = 140,000 / 2,800,000 * 100
Return on Investment = 5%

Answer to Part 4-b.

Yes, this a viable investment as Return on investment is more than the Hurdle Rate.