Question

The company has two parts, General and advance, both are investment centers. The following information was collected from their ’ 2020 financial statements:

General

Advance

Net operating income (in $ thousands)

18000

8000

Sales (in $ thousands)

180000

88000

End of year operating assets (in $ thousands)

70000

33000

Variable cost (as a fraction of total costs)

0.49

0.49

Average selling price per unit

13.26

15.21

Assume end of year, rather than average, assets are used in all relevant calculations. The company's cost of capital is 0.111.

a) Calculate General part's ROI (3 digits, don't express as a percentage).

b) What is General part's residual income (report in thousands of dollars as a whole number)?

c) Calculate Advance part's ROI (3 digits, don't express as a percentage).

d) What is Advance part's residual income (report in thousands of dollars as a whole number)?

e) General part’s manager is planning to buy new machines to expand production. The new machine would increase fixed manufacturing costs by $1361 thousand annually and leave variable costs per unit unchanged. Operating assets would increase by $6027 thousand (The company would need to borrow additional funds to provide this capital). The company could expand sales volume by 2288 thousand units. To increase sales, the price would need to be cut by $0.77.

What is the annual differential profit for the company from the new machine (in $ thousand)?

f) Based on the information in the prior question, what would General part's ROI be if the new equipment is installed? (Again 3 digits.)

g)Another decision under consideration would increase operating profit of the Advance part by $1000 thousand and operating assets by $4674 thousand. Assume the manager of Advance part is evaluated based on ROI. Would the Advance manager choose to do what is in the company's best interest in making this decision? (Answer 2 for yes, 1 for no.)

What is the annual differential profit for Beatrice from the equipment upgrade (in $ thousand)?

Please show all steps.

Answer 1

As per policy, only first 4 subparts are being asnwered. Please ask the question again for the rest of the subparts.

a) General Part's ROI = Net Income / End of year Operating Assets = 18000 / 70000 = 0.257

b) General Part's Residual Income = End of year Operating Assets * (ROI - Cost of Capital) = 70000 * (0.257 - 0.111) = 70000 * 0.146 = $ 10220 (in $ thousands)

c) Advance Part's ROI = Net Income / End of year Operating Assets = 8000 / 33000 = 0.242

d) Advance Part's Residual Income = End of year Operating Assets * (ROI - Cost of Capital) = 33000 * (0.242 - 0.111) = 33000 * 0.131 = $ 4323 (in $ thousands)