# Exercises

Note by Mariah Bruce, updated 5 months ago Created by Mariah Bruce 5 months ago 0 0

### Description

Accounting (Decentralized Performance Evaluation) Note on Exercises, created by Mariah Bruce on 06/04/2020. ## Resource summary

### Page 1

#### ROI &amp; Residual Income A

Violet Company has the following financial data: Sales = \$520,000 Net Operating Income = \$310,000 Average Invested Assets = \$940,000 Hurdle Rate = 12% Calculate Violet's return on investment and its residual income. SOLUTION: Return on Investment (ROI) = Net Operating Income/Average Invested Assets                                                   = \$310,000/\$940,000                                                   = 32.98% Residual Income (Loss) = Operating Income - (Average Invested Assets X Hurdle Rate)                                           = \$310,000 - (\$940,000 X 10%)                                           = \$310,000 - \$94,000                                           = \$216,000

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#### ROI &amp; Residual Income B

Augusta Corp's Golf Division has the following financial data: Sales Revenue = \$200,000  Cost of Goods Sold = \$105,000  Operating Expenses = \$35,000 Average Invested Assets = \$900,000  Hurdle Rate = 12% Calculate the Golf Division's return on investment and its residual income: SOLUTION: Net Operating Income = Sales Revenue - Cost of Goods Sold - Operating Expenses                                          = \$200,000 - \$105,000 - \$35,000                                          = \$60,000 Return on Investment (ROI) = Net Operating Income / Average Invested Assets                                                   = \$60,000 / %90,000                                                   = 6.7% Residual Income (Loss) = Net Operating INcome - (Average Invested Assets X Hurdle Rate)                                           = \$60,000 - (\$900,000 X 12%)                                           = \$60,000 - \$108,000                                           = \$(48,000)

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#### ROI &amp; Residual Income C

Coolbrook Company has the following financial data:                                                                River Division     Stream Division Sales Revenue                                        \$1,200,000          \$1,800,000 COGS and operating expenses               (900,000)          (1,300,000) Net operating Income                              \$300,000             \$500,000 Average Invested Assets                       \$1,200,000          \$1,800,000    The company's hurdle rate is 6%.                                                                                                                                                        SOLUTION: ROI = Net Operating Division / Average Invested Assets Residual Income (Loss) = Net Operating Income - (Average Invested Assets X Hurdle Rate)                                                                                                                                                         1.) Calculate the Return on Investment (ROI) and residual income for each division last year:      River Division                  ROI = \$300,000 / \$1,200,000 = 25.00%                  Residual Income = \$300,000 - (\$1,200,000 X 6%) = \$228,000                                                   Stream Division                  ROI = \$500,000 / \$1,800,000 = 27.80%                  Residual Income =   \$500,000 - (\$1,800,000 X 6%) = \$392,000                                                                                                                                                         2.) Calculate ROI and residual income for each division for the independent situation where               operating income increases by 10%:       River Division                   ROI = (\$300,000 X 110%) / \$1,200,000 = 27.50%                   Residual Income = \$330,000 - (\$1,200,000 X 6%) = \$258,000       Stream Division                   ROI = (\$500,000 X 110%) / \$1,800,000 = 30.56%                   Residual Income = \$550,000 - (\$1,800,000 X 6%) = \$442,000                                                                                                                                                           3.) Caulculate ROI and residual income for each division for the independent situation where operating income decreases by 10%: River Division             ROI = (\$300,000 X 90%) / \$1,200,000 = 22.50%             Residual Income = \$270,000 - (\$1,200,000 X 6%) = \$198,000 Stream Division             ROI = (\$500,000 X 90%) / \$1,800,000 = 22.50%             Residual Income (Loss) = \$450,000 - (\$1,800,000 X 6%) = \$342,000                                                                                                                                                            4.) Calculate ROI and residual income for each division for the independent situation that follows: The company invests \$250,000 in each division, an amount that generates \$100,000 additional income per division: River Division             ROI = (\$300,000 + \$100,000) / (\$1,200,000 + \$250,000) = 27.59%             Residual Income = \$400,000- (\$1,450,000 X 6%) = \$313,000 Stream Division             ROI = (\$500,000 + \$100,000) / (\$1,800,000 + \$250,000)  = 29.27%             Residual Income = \$600,000 - (\$2,050,000 X 6%) = \$477,000                                                                                                                                                                5.) Calculate ROI and residual income for each division for the independent situation where Colbrook changes its hurdle rate to 10%. NO EFFECT on return on investment since it does not incorporate the hurdle rate. River Division             Residual Income = \$300,000 - (\$1,200,000 X 10%) = \$180,000 Stream Division            Residual Income = \$500,000 - (\$1,800,000 X 10%) = \$320,000

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#### ROA &amp; Residual Income D

Wescott Company has three divisions: A, B, and C. The company has a hurdle rate of 8%. Selected operating data for the three divisions are as follows:                                                                      Division A                     Division B                     Division C Sales Revenue                                          \$1,255,000                      \$920,000                     \$898,000 Cost of Goods Sold                                       776,000                        675,000                        652,000 Miscellaneous Operating Expenses             64,000                          52,000                          53,100 Interest and Taxes                                           48,000                          41,000                          41,500 Average Invested Assets                           8,300,000                     1,930,000                     3,215,000                                                                                                                                                                       SOLUTION: 1.) Compute ROI for each division: Division A ROI = \$415,000 / \$8,300,000 = 5% Division B ROI = \$193,000 / \$1,930,000 = 10% Division C ROI = \$192,900 / \$3,21,000 = 6%                                                                                                                                                                        2.) Compute the Residual Income for each division: Division A RI Division A = \$415,000 - (\$8,300,000 X 8%) = \$(249,000) Division B RI Division B = \$93,000 - (\$1,90,000 X 8%) = \$38,600 Division C RI Division C = \$192,900 - (\$3,215,000 X 8%) = \$(64,300)                                                                                                                                                                       3.) Rank the divisions according to the ROI and residual income of each (best to worst): Division B, Division C, Division A                                                                                                                                                                       4.) Compute the Return on Investment on the proposed expansion project: Compute the return on investment on the proposed expansion project: \$450,000 / \$5,000,000 = 9% Yes, this is an acceptable project. The project generates a 9% return which is above the company's given hurdle rate of 8%.                                                                                                                                                                        5.) State whether the proposed project would increase or decrease each division's ROI: Division A - Increase Division B - Decrease Division C - Increase Both Division A and Division C would accept this project because its ROI is greater than either divisions current ROI. Therefore, the project would increase the ROI for either A or C. However, DIvision B currently has an ROI of 10% so the project would actually decrease the divisions ROI if accepted. Even though the project exceeds Wescott's hurdle rate. Division B would prefer to reject the project.                                                                                                                                                                       6.) Compute the new ROI and residual income for each division if the project was implemented within that division:                                                                 ROI                                  Residual Income (Loss) Division A                                               6.50%                              \$(199,000) Division B                                               9.28%                              \$88,600 Division C                                               7.83%                              \$(14,300)   ROI Division A = (\$415,000 + 450,000) / (\$8,300,000 + \$5,000,000) = 6.50%             RI Division A = (\$415,000 + \$450,000) - ((\$8,300,000 + \$5,000,000) X 8%) = \$(199,000) ROI Division B = (\$193,000 + \$450,000) / (\$1,930,000 + \$5,000,000) = 9.28%             RI DIvision B = (\$193,000 + \$450,000) - ((\$1,930,000 + \$5,000,000) X 8%) = \$88,600 ROI Division C = (\$192,900 + \$450,000) / (\$3,215,000 + \$5,000,000) = 7.83%             RI Division C = (\$192,900 + \$450,000) - ((\$3,215,000 + \$5,000,000) X 8%) = \$(14,300)

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