EXERCISES AND MODEL QUESTIONS (ROI/RI/EVA)
1. The following results for the current year are for the Grundy Division
of Salmon Enterprises:
Sales
$700,000
Variable costs
260,000
Contribution margin
$440,000
Fixed expenses
300,000
Divisional income
$140,000
Total assets is $1,400,000. The firm’s minimum required rate of return
is 8 percent. The weighted average cost of capital is 6 percent. The
division’s tax rate is 30 percent.
Required:
a.
Calculate profit margin for the division.
b.
Calculate asset turnover for the division.
c.
Calculate return on investment (ROI) for the division.
d.
What is residual income (RI)?
e.
Calculate economic value added (EVA) for the division if average current
liabilities is $ 200,000 ,.
ANS:
a.
20% $140,000/$700,000
b.
50% $700,000/$1,400,000
c.
10% $140,000/$1,400,000
d.
$28,000 $140,000 – ($1,400,000 x 8%)]
e.
$26,000 [$140,000 x (1 – .3)] – [($1,400,000 – $200,000) x 6%]
2. The manager of the recently formed Oak Division of Parkes Incorporated
is evaluating the following four investment opportunities available to
the division. Parkes Incorporated requires a minimum return of 10
percent.
Investment
Opportunity
Income
Investment
1
$ 91,000
$650,000
2
63,000
700,000
3
59,400
540,000
4
117,600
980,000
Required:
a.
Calculate the return on investment (ROI) for each investment opportunity.
b.
If only one investment opportunity can be funded and the division is
evaluated based on ROI, which investment opportunity would be accepted?
c.
If Parkes Incorporated can fund all of the projects and wishes to achieve
the best possible performance, which investments would be accepted?
ANS:
a.
Project 1: 14% $91,000/$650,000
Project 2: 9% $63,000/$700,000
Project 3: 11% $59,400/$540,000
Project 4: 12% $117,600/$980,000
b.
Project 1, because it has the highest ROI
c.
Projects 1, 3, and 4; their ROIs exceed the minimum return of 10 percent.
3. TotToys Corporation recently made $2,000,000 of capital available to
its Toddler Division. The manager of the Toddler Division is
evaluating the possibility of investing the additional funds in two new
toys. Information about the two new toys is as follows:
Toy #1
Toy #2
Projected investment
$900,000
$750,000
Expected operating income
144,000
90,000
Any funds not invested in a project will be invested to earn the
company’s required minimum return of 10 percent. Without the
additional investment, the Toddler Division’s average operating assets
would have been $10,000,000, and its operating income would have been
$1,400,000.
Required:
a.
Compute the Toddler Division’s operating income and ROI, assuming that the
division manager rejects both projects.
b.
Compute the Toddler Division’s operating income and ROI, assuming that the
division manager accepts only the Toy #1 project.
c.
Compute the Toddler Division’s operating income and ROI, assuming that the
division manager accepts only the Toy #2 project.
d.
Compute the Toddler Division’s operating income and ROI, assuming that the
division manager accepts both projects.
(Round all computations to the nearest two decimal places.)
ANS:
a.
$1,600,000 $1,400,000 + ($2,000,000 x 10%)
13.33% $1,600,000/($10,000,000 + $2,000,000)
b.
$1,654,000 $1,400,000 + $144,000 + [($2,000,000 – $900,000) x 10%]
13.78% $1,654,000/($10,000,000 + $2,000,000)
c.
$1,615,000 $1,400,000 + $90,000 + [($2,000,000 – $750,000) x 10%]
13.46% $1,615,000/($10,000,000 + $2,000,000)
d.
$1,669,000 $1,400,000 + $144,000 + $90,000 +
[($2,000,000 – $900,000 – $750,000) x 10%]
13.91% $1,669,000/($10,000,000 + $2,000,000)
4. The following results for the current year are for the Calvin Division
of Stinson Enterprises:
Sales
$400,000
Variable costs
180,000
Contribution margin
$220,000
Fixed expenses
160,000
Divisional income
$ 60,000
Average total assets is $500,000. The firm’s minimum required rate of
return is 10 percent, the weighted average cost of capital is 8
percent, and the tax rate is 30 percent.
Required:
a.
Calculate profit margin for the division.
b.
Calculate asset turnover for the division.
c.
Calculate return on investment (ROI) for the division.
d.
Calculate residual income (RI) for the division.
e.
Calculate economic value added (EVA) for the division if average current
liabilities is $50,000.
ANS:
a.
15% $60,000/$400,000
b.
80% $400,000/$500,000
c.
12% $60,000/$500,000
d.
$10,000 $60,000 – ($500,000 x 10%)
e.
$6,000 [$60,000 x (1 – .3)] – [($500,000 – $50,000) x 8%]
5. Brothers, Incorporated, has just formed a new division, and the
following four investment opportunities are available to the division.
The firm requires a minimum return of 8 percent.
Investment
Opportunity
Income
Investment
1
$57,600
$ 640,000
2
75,000
600,000
3
60,000
1,000,000
4
59,500
850,000
Required:
a.
Calculate the return on investment (ROI) for each investment opportunity.
b.
If you were the division manager and you were evaluated based on ROI,
which investment opportunity would you accept?
c.
If you were president of Brothers, Incorporated, which projects would you
want the division to accept?
ANS:
a.
Project 1: 9% $57,600/$640,000
Project 2: 12.5% $75,000/$600,000
Project 3: 6% $60,000/$1,000,000
Project 4: 7% $59,500/$850,000
b.
Project 2, because it has the highest ROI
c.
Projects 1 and 2
6. Ritter Company reported the following information during 2006.
Sales revenue
$400,000
Operating income
$16,000
Average operating assets
?
Return on investment
?
Margin
4%
2
Sales revenue
?
Operating income
Average operating assets
$200,000
Return on investment
Turnover
?