37336176-CH-23-Solutions-Horngren-13th-Edition

37336176-CH-23-Solutions-Horngren-13th-Edition - CH 23...

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CH 23 Solutions Horngren 13 th Edition 23-18(10–15 min.) ROI and RI . 1. Operating income = (Contribution margin per unit × 150,000 units) – Fixed costs = ($720 – $500) × 150,000 – $30,000,000 = $3,000,000 ROI = Investment income Operating = $3,000,000 ÷ $48,000,000 = 6.25% 2. Operating income = ROI × Investment [No. of pairs sold (Selling price – Var. cost per unit)] – Fixed costs = ROI × Investment Let $X = minimum selling price per unit to achieve a 25% ROI 150,000 ($X – $500) – $30,000,000 = 25% ($48,000,000) $150,000X = $12,000,000 + $30,000,000 + $75,000,000 X = $780 3. Let $X = minimum selling price per unit to achieve a 20% rate of return 150,000 ($X – $500) – $30,000,000 = 20% ($48,000,000) $150,000X = $9,600,000 + $30,000,000 + $75,000,000 X = $764 1. The required division ROIs using total assets as a measure of investment is shown in the row labeled (1) in Solution Exhibit 23-22. SOLUTION EXHIBIT 23-22 New Car Division Performance Parts Division Total assets $33,000,000 $28,500,00 0 Current liabilities $6,600,000 $8,400,000 Operating income $2,475,000 $2,565,000 Required rate of return 12% 12% Total assets – current liabilities $26,400,000 $20,100,00 0 (1) ROI (based on total assets) ($2,475,000 ÷ $33,000,000; $2,565,000 ÷ $28,500,000) 7.5% 9.0% (2) RI (based on total assets – current liabilities) ($2,475,000 – (12% × $26,400,000); $2,565,000 – (12% × $20,100,000)) ($693,000) $153,000 (3) RI (based on total assets) ($2,475,000 – (12% × $33,000,000); $2,565,000 – (12% × $28,500,000)) ($1,485,000) ($855,000) 2. The required division RIs using total assets minus current liabilities as a measure of investment is shown in the row labeled (2) in the table above. 3. The row labeled (3) in the table above shows division RIs using assets as a measure of investment. Even with this new measure that is insensitive to the level of short-term debt, the New Car Division has a relatively
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worse RI than the Performance Parts Division. Both RIs are negative, indicating that the divisions are not earning the 12% required rate of return on their assets. 4. After-tax cost of debt financing = (1– 0.4) × 10% = 6% After-tax cost of equity financing = 15% Weighted average = cost of capital ($18,000,000 6%) + ($12,000,000 15%) $18,000,000 + $12,000,000 × × = 9.6% Operating income after tax 0.6 × operating income before tax $ 1,485,000 $1,539,000 (0.6 × $2,475,000; 0.6 × $2,565,000) Required return for EVA 9.6% × Investment (9.6% × $26,400,000; 9.6% × $20,100,000) 2,534,400 1,929,600 EVA (Optg. inc. after tax – reqd. return) $(1,049,400 ) $ (390,600 ) 5. Both the residual income and the EVA calculations indicate that the Performance Parts Division is
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37336176-CH-23-Solutions-Horngren-13th-Edition - CH 23...

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