Gen Combo Loose Leaf Financial Accounting; Connect Access Card
Gen Combo Loose Leaf Financial Accounting; Connect Access Card
18th Edition
ISBN: 9781264094295
Author: williams
Publisher: MCG
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Chapter 25, Problem 5AP

a.

To determine

Identify the project that would be chosen by Person B for investment, if Person B’s objective were to maximize the location’s ROI.

a.

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

The projects that are having ROI greater than or equal to 14% would be attractive to Person B and would improve the ROI of Person B’s location. Project A-1 and A-2 are having ROI of 14.1% and 20.0% respectively, which would be attractive to Person B to improve the ROI  of the current location.

b.

To determine

Identify the project that would increase the value of Incorporation F.

b.

Expert Solution
Check Mark

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

The projects that are having ROI above the minimum required return established for Incorporation F of 12% would increase the value of Incorporation F. Projects A-1, A-2, A-3, and A-4 are likely to increase the value of Incorporation F. However, Project A-5 would not be acceptable.

c.

To determine

Identify the project that would have a negative 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}

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 residual income (loss) of each project.

ProjectOperating IncomeResidual Income (loss)
A-1$150,000×14.1%=$21,150$21,150($150,000×12%)=$ 3,150
A-2$300,000×20.0%=$60,000$60,000($300,000×12%)=$24,000
A-3$250,000×13.5%=$33,750$33,750($250,000×12%)=$3,750
A-4$400,000×12.5%=$50,000$50,000($400,000×12%)=$2,000
A-5$500,000× 9.8%=$49,000$49,000($500,000×12%)=($11,000)

Table (1)

As per Table (1), Project A-5 is having residual income (Loss) of ($11,000).

d.

To determine

Create two rankings for the projects in order of acceptability if Person B is evaluated (1) on ROI and (2) on residual income.

d.

Expert Solution
Check Mark

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}

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

Rank the projects in order of acceptability based (1) on ROI.

ProjectRequired capitalROIRanking
A-1$150,00014.1%2
A-2$300,00020.0%1
A-3$250,00013.5%3
A-4$400,00012.5%4
A-5500,0009.8%5

Table (2)

On the basis of ROI, Project A-2 and Project A-1 would be acceptable by Person B because the ROI yields 14.1% and 20.0% respectively which is higher than the current ROI of 14%.

Rank the projects in order of acceptability based (2) on residual income

ProjectOperating IncomeResidual Income (loss)Ranking
A-1$150,000×14.1%=$21,150$21,150($150,000×12%)=$ 3,1503
A-2$300,000×20.0%=$60,000$60,000($300,000×12%)=$24,0001
A-3$250,000×13.5%=$33,750$33,750($250,000×12%)=$3,7502
A-4$400,000×12.5%=$50,000$50,000($400,000×12%)=$2,0004
A-5$500,000× 9.8%=$49,000$49,000($500,000×12%)=($11,000)5

Table (3)

On the basis of residual income, Project A-2 and Project A-3 would be acceptable because the residual income is $24,000 and $3,750 respectively which are higher than the residual income of other projects.

e.

To determine

On the basis of the projects, explain the reasons behind the problem of under –investment using ROI as a tool of evaluation.

e.

Expert Solution
Check Mark

Explanation of Solution

As per Table (2), the Project A-1 would be preferred over Project A-3 because Project A-1 yields a ROI of 14.1% which is higher than the current ROI of 14%. On the other hand, Project A-3 yields a ROI of 13.5% which is lower than the current ROI of 14%.

As per Table (3), the Project A-3 would be preferred over Project A-1 because the residual income from Project A-3 is $3,750 with an invested capital of $250,000. On the other hand, the residual income from Project A-1 is $3,150 with an invested capital of $150,000. The residual income of Project A-3 is higher than the residual income of Project A-1.

If Person B is evaluated on the basis of ROI, then Project A-1 or Project A-2 would be considered because they are the projects that would raise the current ROI of 14%.

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Chapter 25 Solutions

Gen Combo Loose Leaf Financial Accounting; Connect Access Card

Ch. 25 - Prob. 6DQCh. 25 - Prob. 7DQCh. 25 - Prob. 8DQCh. 25 - Prob. 9DQCh. 25 - Prob. 10DQCh. 25 - Prob. 11DQCh. 25 - Prob. 12DQCh. 25 - Prob. 13DQCh. 25 - Prob. 14DQCh. 25 - Prob. 15DQCh. 25 - Prob. 1BECh. 25 - Prob. 2BECh. 25 - Prob. 3BECh. 25 - LO25-5 BRIEF EXERCISE 25.4 Balanced...Ch. 25 - LO25-2, LO25-3 BRIEF EXERCISE 25.5 Computations...Ch. 25 - LO25-3 BRIEF EXERCISE 25.6 Criticisms of...Ch. 25 - LO25-2, LO25-4 BRIEF EXERCISE 25.7 Calculate...Ch. 25 - LO25-4 BRIEF EXERCISE 25.8 Calculate EVA The...Ch. 25 - LO25-6 BRIEF EXERCISE 25.9 Variable versus Fixed...Ch. 25 - LO25-2 BRIEF EXERCISE 25.10 Components of...Ch. 25 - LO25-2, LO25-3, LO25-4, LO25-5, LO25-6 EXERCISE...Ch. 25 - Prob. 2ECh. 25 - LO25-1 EXERCISE 25.3 Employee Motivation Assume...Ch. 25 - LO25-2, LO25-3, LO25-4 EXERCISE 25.4 ROI versus...Ch. 25 - Prob. 5ECh. 25 - Prob. 6ECh. 25 - Prob. 7ECh. 25 - Prob. 8ECh. 25 - Prob. 9ECh. 25 - Prob. 10ECh. 25 - Prob. 11ECh. 25 - Prob. 12ECh. 25 - Prob. 13ECh. 25 - Prob. 14ECh. 25 - Prob. 15ECh. 25 - Prob. 1APCh. 25 - Prob. 2APCh. 25 - Prob. 3APCh. 25 - Prob. 4APCh. 25 - Prob. 5APCh. 25 - LO25-5, LO25-6 PROBLEM 25.6A Balanced Scorecard...Ch. 25 - Prob. 7APCh. 25 - Prob. 8APCh. 25 - Prob. 9APCh. 25 - Prob. 1BPCh. 25 - Prob. 2BPCh. 25 - LO25-1, LO25-2, LO25-3, LO25-4 PROBLEM...Ch. 25 - Prob. 4BPCh. 25 - Prob. 5BPCh. 25 - LO25-5, LO25-6 PROBLEM 25.6B Balanced Scorecard in...Ch. 25 - Prob. 7BPCh. 25 - Prob. 8BPCh. 25 - Prob. 9BPCh. 25 - Prob. 1CTCCh. 25 - Prob. 2CTCCh. 25 - Prob. 6CP
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