a.
Calculate the F division’s residual income if Company O does not acquire the new machine.
a.
Answer to Problem 45P
The residual income for division S is $3,000,000 if Company O does not acquire the new machine.
Explanation of Solution
Residual income:
Residual income is the amount of profit that is left after adjusting the cost of capital of the business. It is calculated by subtracting the profit after tax from the total cost of capital invested in the business unit.
Calculate the residual income if Company O does not acquire the new machine:
Thus, the residual income for division S is $3,000,000.
Working note 1:
Calculate the net asset value:
Particulars | Amount |
Opening asset value | $4,000,000 |
Add: addition in the year | $5,000,000 |
Total asset value | $9,000,000 |
Less: | $1,500,000 |
Less: depreciation on others | $1,250,000 |
Net asset value | $6,250,000 |
Table: (1)
b.
Calculate the division F’s residual income if Company O acquires the new machine
b.
Answer to Problem 45P
The residual income is $860,000 if Company O acquires the new machine.
Explanation of Solution
Adjusted residual income:
Adjusted residual income is calculated by changing the profit and investment of the company as per the new business proposal.
Calculate the residual income if Company O acquires the new machine:
Thus, the residual income is $860,000 if Company O acquires the new machine.
Working note 2:
Calculate the net asset value:
Particulars | Amount |
Opening asset value | $4,000,000 |
Add: improvement in the asset | $6,500,000 |
Total asset value | $10,500,000 |
Less: depreciation on others | $1,250,000 |
Net asset value | $9,250,000 |
Table: (2)
Working note 3:
Calculate the after-tax divisional profit:
Particulars | Amount |
Operating profit | $3,750,000 |
Less: loss on old equipment | $5,000,000 |
Add: saving in the depreciation of old equipment | $1,500,000 |
Net operating profit | $250,000 |
Table: (3)
c.
Calculate the residual income if the company acquires new machine and operates it according to specifications.
c.
Answer to Problem 45P
The residual income is $4,305,000 if the machine is operated as per the specifications.
Explanation of Solution
Residual income:
Residual income is the amount of profit that is left after adjusting the cost of capital of the business. It is calculated by subtracting the profit after tax from the total cost of capital invested in the business unit.
Calculate the residual income if the machine is operated as per the specifications:
Thus, the residual income is $4,305,000 if the machine is operated as per the specifications.
Working note 4:
Calculate the divisional operating income:
Particulars |
Amount (a) |
% change (b) |
Net amount |
Sales | $16,000,000 | +10% | $17,600,000 |
Operating costs: | |||
Variable | $2,000,000 | +10% | $2,200,000 |
Fixed | $7,500,000 | -5% | $7,125,000 |
Deprecation: | |||
New equipment(6) | $1,500,000 | $2,000,000 | |
Others | $1,250,000 | $1,250,000 | |
Divisional operating profit | $5,025,000 |
Table: (4)
Working note 5:
Calculate the net asset value:
Particulars | Amount |
Opening asset value | $4,000,000 |
Add: improvement in the asset | $6,500,000 |
Total asset value | $10,500,000 |
Less: depreciation on others | $2,500,000 |
Less: depreciation on improved assets (6) | $2,000,000 |
Net asset value | $6,000,000 |
Table: (5)
Working note 6:
Calculate the depreciation on new equipment:
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Chapter 14 Solutions
FUNDAMENTALS OF COST ACCOUNTING
- The income statement comparison for Rush Delivery Company shows the income statement for the current and prior year. A. Determine the operating income (loss) (dollars) for each year. B. Determine the operating income (percentage) for each year. C. The company made a strategic decision to invest in additional assets in the current year. These amounts are provided. Using the total assets amounts as the investment base, calculate the ROI. Was the decision to invest additional assets in the company successful? Explain. D. Assuming an 8% cost of capital, calculate the RI for each year. Explain how this compares to your findings in part C.arrow_forwardReturn on Investment and Economic Value Added Calculations with Varying Assumptions Knitpix Products is a division of Parker Textiles Inc. During the coming year, it expects to earn income of 310,000 based on sales of 3.45 million. Without any new investments, the division will have average operating assets of 3 million. The division is considering a capital investment projectadding knitting machines to produce gaitersthat requires an additional investment of 600,000 and increases net income by 57,500 (sales would increase by 575,000). If made, the investment would increase beginning operating assets by 600,000 and ending operating assets by 400,000. Assume that the actual cost of capital for the company is 7%. (Note: Round all answers to four decimal places.) Required: 1. Compute the ROI for the division without the investment. 2. Compute the margin and turnover ratios without the investment. Show that the product of the margin and turnover ratios equals the ROI computed in Requirement 1. 3. CONCEPTUAL CONNECTION Compute the ROI for the division with the new investment. Do you think the divisional manager will approve the investment? 4. CONCEPTUAL CONNECTION Compute the margin and turnover ratios for the division with the new investment. How do these compare with the old ratios? 5. CONCEPTUAL CONNECTION Compute the EVA of the division with and without the investment. Should the manager decide to make the knitting machine investment?arrow_forwardUse the following information for Exercises 11-31 and 11-32: Washington Company has two divisions: the Adams Division and the Jefferson Division. The following information pertains to last years results: Washingtons actual cost of capital was 12%. Exercise 11-32 Residual Income Refer to the information for Washington Company above. In addition, Washington Companys top management has set a minimum acceptable rate of return equal to 8%. Required: 1. Calculate the residual income for the Adams Division. 2. Calculate the residual income for the Jefferson Division.arrow_forward
- Use the following information for Exercises 11-31 and 11-32: Washington Company has two divisions: the Adams Division and the Jefferson Division. The following information pertains to last years results: Washingtons actual cost of capital was 12%. Exercise 11-31 Economic Value Added Refer to the information for Washington Company above. Required: 1. Calculate the EVA for the Adams Division. 2. Calculate the EVA for the Jefferson Division. 3. CONCEPTUAL CONNECTION Is each division creating or destroying wealth? 4. CONCEPTUAL CONNECTION Describe generally the types of actions that Washingtons management team could take to increase Jefferson Divisions EVA?arrow_forwardIncome statements for two different companies in the same industry are as follows: Required: 1. Compute the degree of operating leverage for each company. 2. Compute the break-even point for each company. Explain why the break-even point for Quintex, Inc., is higher. 3. Suppose that both companies experience a 50 percent increase in revenues. Compute the percentage change in profits for each company. Explain why the percentage increase in Quintexs profits is so much greater than that of Trimax.arrow_forwardSuppose you are analyzing a firm that is successfully executing a strategy that differentiates its products from those of its competitors. Because of this strategy, you project that next year the firm will generate 6.0% revenue growth from price increases and 3.0% revenue growth from sales volume increases. Assume that the firms production cost structure involves strictly variable costs. (That is, the cost to produce each unit of product remains the same.) Should you project that the firms gross profit will increase next year? If you project that the gross profit will increase, is the increase a result of volume growth, price growth, or both? Should you project that the firms gross profit margin (gross profit divided by sales) will increase next year? If you project that the gross profit margin will increase, is the increase a result of volume growth, price growth, or both?arrow_forward
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