Financial & Managerial Accounting
Financial & Managerial Accounting
17th Edition
ISBN: 9780078025778
Author: Jan Williams, Susan Haka, Mark S Bettner, Joseph V Carcello
Publisher: McGraw-Hill Education
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Chapter 25, Problem 1BP

a.

To determine

Compute return on investment for each department and use DuPont method to analyze the return on sales and capital turnover.

a.

Expert Solution
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Explanation of Solution

DuPont model: It is a model which allows the analyst to analyse a company’s performance using the return on sale and capital turnover ratios. This ratio analyses the company’s performance by considering the earnings per sales dollar and the sales generated per capital invested. DuPont model equation is as follows:

Return on Investment (ROI)}=Capital turnover×Return on salesOperating incomeAverage total assets=Net salesAverage total assets×Operating earningsNet sales

Determine the return on investment for each department.

ParticularsGolf coursesRestaurantsPro Shops

Complex TCG

(Note 1)

Return On Sales    
Operating earnings (A)$4,000,000$1,400,000$200,000$5,600,000
Sales revenue (B)$14,000,000$2,500,000$700,000$17,200,000
     
Return on sales (1)(A)÷(B)28.6%56%28.6%32.6%
 
Capital Turnover    
Sales revenue (A)$14,000,000$2,500,000$700,000$17,200,000
Average investment (B)$10,000,000$6,000,000$1,200,000$17,200,000
     
Capital Turnover (2)(A)÷(B)140%41.7%58.3%100%
 
Return On Investment    
Operating earnings (A)$4,000,000$1,400,000$200,000$5,600,000
Average investment (B)$10,000,000$6,000,000$1,200,000$17,200,000
     
Return on investment(1)×(2)40%23.3%16.7%32.6%

Table (1)

Note: The ratios of all three departments are added together in Complex TCG column.

As per Table (1), the return on sales for the Department Golf courses is 28.6% which is the lowest among other departments and the capital turnover for Department Golf course is 140% which is highest among other departments. This is because of the heavy investment made in the assets of Department Golf coursesas compared among other departments.

b.

To determine

Ascertain the ROI of the investment in the new display cases and explain the impact of the investment in the ROI of Department Pro shops. Explain whether the manager of Department Pro shopswould be motivated to undertake such investment.

b.

Expert Solution
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Explanation of Solution

Return on investment (ROI): This financial ratio evaluates how efficiently the assets are used in earning income from operations. So, ROI is a tool used to measure and compare the performance of a units or divisions or a companies. The formula for ROI is as follows:

Return on investment(ROI)  = Operating income Average total investment

Determine the ROI of the new display cases.

Return on investment(ROI)  = Operating income Average total investment=$10,000$60,000=16.7%

Thus, the ROI of the new display cases is 16.7%.

Determine the impact of the new display cases on the ROI of Department Pro shops.

New return on investment(ROI)  = Revised operating income Revised average total investment=$200,000+$10,000$1,200,000+$60,000=$210,000$1,260,000=16.7%

The new return on investment (ROI) is 16.7%. The manager of Department Pro shopswould not be motivated to undertake the investment because the ROI of Department Pro shops would decrease to 16.7%.

c.

To determine

Calculate the residual income for each department if the minimum required return for the Complex TCG is 18 percent and explain the impact of the investment in (b) on the Pro Shop’s residual income.

c.

Expert Solution
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Explanation of Solution

Residual income: Residual income is the excess of income over the minimum acceptable return on average capital invested. The minimum rate of return shows the opportunity cost of using the invested capital. The formula for residual income is as follows:

Residual income  = Operating earnings{(Minimum acceptable return)×Invested capital}

Determine the residual income (loss) for each department.

ParticularsGolf coursesRestaurantsPro Shops
Operating earnings (A)$4,000,000$1,400,000$200,000
    
Minimum acceptable return (B)18%18%18%
Average investment (C)$10,000,000$6,000,000$1,200,000
Minimum acceptable return on average capital invested(D) (B)×(C)$1,800,000$1,080,000$216,000
    
Residual income (E) (A)(D)$2,200,000$320,000$(16,000)

Table (2)

Thus, the residual income (loss) of Department Golf courses, Department Restaurants, and Department Pro Shops are $2,200,000, $320,000, and $(16,000) respectively.

Determine the impact of the new display cases on the residual income of Department Pro Shops.

Residual income  = Operating earnings{(Minimum acceptable return)×Invested capital}=$10,000($60,000×18%)=$10,000$10,800=($800)

If theDepartment Pro Shops buys the new display cases, its residual loss will be reduced by $800.

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Chapter 25 Solutions

Financial & Managerial Accounting

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