Question

Rundle Corporation operates three investment centers. The following financial statements apply to the investment center named Bowman Division:

BOWMAN DIVISION
Income Statement
For the Year Ended December 31, 2018
Sales revenue	$	107,380
Cost of goods sold		59,375
Gross margin		48,005
Operating expenses
Selling expenses		(2,670	)
Depreciation expense		(4,175	)
Operating income		41,160
Nonoperating item
Loss of sale of land		(3,500	)
Net income	$	37,660

BOWMAN DIVISION
Balance Sheet
As of December 31, 2018
Assets
Cash	$	12,602
Accounts receivable		40,456
Merchandise inventory		36,400
Equipment less accumulated depreciation		90,428
Nonoperating assets		10,800
Total assets	$	190,686
Liabilities
Accounts payable	$	9,517
Notes payable		70,000
Stockholders’ equity
Common stock		76,000
Retained earnings		35,169
Total liabilities and stockholder's equity	$	190,686

Required

3. Calculate the ROI for Bowman.

4. Rundle has a desired ROI of 13 percent. Headquarters has $92,000 of funds to assign to its investment centers. The manager of the Bowman Division has an opportunity to invest the funds at an ROI of 15 percent. The other two divisions have investment opportunities that yield only 14 percent. Calculate the new ROI for Bowman division, if the investment opportunity is adopted by Bowman.

5. Based on the original data, calculate the original residual income. Also, calculate the new residual income based on information provided in Requirement d.

Answer 1

Ans.C.

Return on Investment(ROI) = (Net income / Capital invested) * 100

= ($37,660 / ($76,000+$35,169)) * 100

=33.88%

Ans.D.

Additional investment = $92,000

ROI on new investment = 15%, so expected net income = 15% * $92,000 = $13,800

So, if new investment is adopted by Bowman, new total net income = $37,600 + $13,800 = $51,460

Net capital = $76,000 + $35,169 + $92,000 = $203,169

So, new ROI = ($51,460 / $203,169) * 100 = 25.33%

Ans.E.

Residual income = Net income – Cost of equity capital

Rundle has desired ROI of 13%, which means cost of capital = 13%

Original capital invested = $76,000+$35,169 = $111,169

Original residual income = $37,660 – (13%*$111,169)

= $37,660 - $14,451.97 = $23,208.03

Net residual income = $51,460 – (13% * $203,169)

= $51,460 - $26,411.97

= $25,048.03