PA10-2 Calculating Unknowns, Predicting Relationship among Return on Investment,
ID: 2559769 • Letter: P
Question
PA10-2 Calculating Unknowns, Predicting Relationship among Return on Investment, Residual Income, Hurdle Rates [LO 10-4, 10-5]
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.
Required:
1. Without making any calculations, determine whether each division’s return on investment is above or below 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.)
3. What is Charleston’s hurdle rate? (Round your answer to 1 decimal place, (i.e. 0.123 should be entered as 12.3%.))
4-a. Suppose Charleston has the opportunity to invest additional assets to help expand the company’s market share. The expansion would require an average investment of $2,800,000 and would generate $140,000 in additional income. Calculate the return on investment of the proposed expansion.
4-b. From Charleston’s perspective, is this a viable investment?
5. Suppose the two divisions would equally share the investment and profits from the expansion project. If return on investment is used to evaluate performance, what will each division manager think about the proposed project?
Explanation / Answer
Answer 1. Bermuda Division has a return on investment above Charleston's Hurdle Rate. Because Bermuda Division has a positive residual income. Answer 2. Bermuda Division Midiron Division Sales Revenue 800,000 600,000 $160,000 / 20% Average Invested Assets 2,500,000 3,750,000 $600,000 / 0.16 Net Operating Income 160,000 150,000 Profit Margin 20% 25% $150,000 / $600,000 Investment Turnover 0.32 0.16 $800,000 / $2,500,000 Return on Investment 6.40% 4.00% $160,000 / $2,500,000 $150,000 / $3,750,000 Residual Income 40,000 (30,000) Answer 3. Bermuda Division: Residual Income = Operating Income - (Avg. Invested Assets X Hurdle Rate) $40,000 = $160,000 - ($2,500,000 X Hurdle Rate) $2,500,000 X Hurdle Rate = $120,000 Hurdle Rate = 4.80% Midiron Division: Residual Income = Operating Income - (Avg. Invested Assets X Hurdle Rate) -$30,000 = $150,000 - ($3,750,000 X Hurdle Rate) $3,750,000 X Hurdle Rate = $180,000 Hurdle Rate = 4.80% Answer 4-a. Return on Investments = $140,000 / $2,800,000 Return on Investments = 5% Answer 4-b. Yes, this is a Viable Investment Because it is above the Hurdle Rate.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.