Module+12000+VI+Homework

VI. Module 12000 Homework amb

* The information below is provided by //Cornerstones for Cost Accounting// textbook. Multidiv, Inc., provided the following information for two of its divisions for last year:
 * Information:**
 * Cornerstone 10-1 p. 477-478**

 **Snack Foods Division** **Appliance Division** Sales $30,000,000 $117,000,000 Operating Income 1,800,000 3,510,000 Operating assets, January 1 9,600,000 17,500,000 Operating assets, December 31 10,400,000 21,500,000

Return on investment is a key measure of performance. It relates the income earned to the investment needed to produce that income. It is appropriate for companies and for investment centers. **Solution:** = ($9,600,000 + $10,400,000) / 2 = **__$10,000,000__**
 * Why:**
 * Required:**
 * 1) For the Snack Foods Division, calculate:
 * 2) Average operating assets
 * 3) Margin
 * 4) Turnover
 * 5) Return on investment (ROI)
 * 6) For the Appliance Division, calculate:
 * 7) Average operating assets
 * 8) Margin
 * 9) Turnover
 * 10) Return on investment (ROI)
 * 11) What if ending assets for the Snack Foods Division were $14,400,000? How would that affect average operating assets? Margin? Turnover? ROI?
 * 1) a. Average operating assets = (Beginning assets + Ending assets) / 2

b. Margin = Operating income / Sales = $1,800,000 / $30,000,000 = **__0.06 or 6%__** c. Turnover = Sales / Average operating assets = $30,000,000 / $10,000,000 = **__3.0__**  d.ROI = Margin X Turnover = 0.06 X 3.0 = **__0.18 or 18%__** **OR**

ROI = Operating income / Average operating assets = $1,800,000 / $10,000,000 = **__0.18 or 18%__** = ($17,500,000 + $21,500,000) / 2 = **__$19,500,000__**  b. Margin = Operating income / Sales = $3, 510,000 / $117,000,000 = **__0.03 or 3%__** c. Turnover = Sales / Average operating assets = $117,000,000 / $19,500,000 = **__6.0__**  d.ROI = Margin X Turnover = 0.03 X 6.0 = **__0.18 or 18%__** **OR**
 * 1) a. Average operating assets = (Beginning assets + Ending assets) / 2

ROI = Operating income / Average operating assets = $3,510,000 / $19,500,000 = **__0.18 or 18%__** Average operating assets = ($9,600,000 + $14,400,000) / 2 = __**$12,000,000**__ Turnover = $30,000,000 / $12,000,000 = __**2.5**__ ROI= 0.06 X 2.5 = **__0.15 or 15%__** **Cornerstone 10-2 p. 481-482**
 * 1) If ending operating assets for the Snack Foods Division were $14,400,000, then the average operating assets would be higher. Higher average operating assets leads to lower turnover and lower ROI. Margin would not be affected. New amounts would be:

**Information:** Multidiv, Inc., provided the following information for two of its divisions for last year:

 **Snack Foods Division** **Appliance Division** Sales $30,000,000 $117,000,000 Operating Income 1,800,000 3,510,000 Average operating assets 10,000,000 19,500,000 Multidiv, Inc., requires a 12 percent minimum rate of return. **Why:** Residual income is measured in dollar amounts rather than percentages. It relates the income earned to the minimum required return on investment and overcomes the tendency for managers to turn down profitable projects that might lower divisional ROI. **Required:**
 * 1) Calculate residual income for the Snack Foods Division.
 * 2) Calculate residual income for the Appliance Division.
 * 3) What if the minimum required rate of return was 16 percent? How would that affect the residual income of the two divisions?

**Solution:** = $1,800,000 – (0.12 X $10,000,000) = **__$600,000__** = $3,510,000 – (0.12 X $19,500,000) = **__$1,170,000__** Snack Foods residual income = $1,800,000 – (0.16 X $10,000,000) = **__$200,000__** Appliance residual income = $3,510,000 – (0.16 X $19,500,000) = **__$390,000__** **Cornerstone 10-3 p.485**
 * 1) Residual income = Operating income – (Minimum rate of return X Operating assets)
 * 1) Residual income = Operating income – (Minimum rate of return X Operating assets)
 * 1) If the minimum rate of return was 16 percent, the residual income of both divisions would be lower.

**Information:** Furman, Inc., had after-tax operating income last year of $1,583,000. Three sources of financing were used by the company: $2 million of mortgage bonds paying 8 percent interest, $3 million of unsecured bonds paying 10 percent interest, and $10 million in common stock, which was considered to be no more or less risky than other stocks. (Over time, stockholders have received an average return that is six percentage points higher than the return on long-term government bonds.) The rate of return on long-term treasury bonds is 6 percent. Furman, Inc., pays a marginal tax rate of 40 percent. **Why:** Economic value added adjusts earnings by the true cost of capital employed. As a result, it is a measure of wealth created or destroyed by a company.

**Required:** **Solution:** =[0.08 –(0.4 X 0.08)]= **__0.048__** After-tax cost of unsecured bonds = Interest rate – (Tax rate X Interest rate) =[0.10 – (0.4 X 0.100]= **__0.06__**  Cost of common stock = Return on long-term treasury bonds + Average premium =0.06 + 0.06=  **__0.12__**  Mortgage bonds $2,000,000 0.1333 0.048 0.0064  Unsecured bonds 3,000,000 0.2000 0.060 0.0120  Common Stock __10,000,000__ 0.6667 0.120 __0.0800__  **Total __$15,00,000__** **__0.0984__**
 * 1) Calculate the after-tax cost of each method of financing.
 * 2) Calculate the weighted average cost of capital for Furman, Inc. Calculate the total dollar amount of capital employed for Furman, Inc.
 * 3) Calculate economic value added (EVA) for Furman, Inc., for last year. Is Furman, Inc., creating or destroying wealth?
 * 4) What if Furman, Inc., had $15 million in common stock and no mortgage bonds or unsecured bonds? How would that affect the weighted average cost of capital? How would it affect EVA?
 * 1) After-tax cost of mortgage bonds = Interest rate – (Tax rate X Interest rate)
 * 1) **AmountPercent X After-Tax Cost = Weighted Cost**

Weighted average percentage cost of capital = **__0.0984 or 9.84%__** Total dollar amount of capital employed = 0.0984 X $15,000,000 = **__$1,476,000__**

Less: Total dollar amount of capital employed __1,476,000__ EVA **__$ 107,000__** Furman, Inc., is creating capital because EVA is positive (the after-tax earnings are greater than the after-tax cost of capital). EVA = $1,583,000 - $1,800,000 = **__$(217,000)__**
 * 1) After-tax operating income $1,583,000
 * 1) If all $15 million of financing were in common stock, the weighted average percentage cost of capital would be 12 percent and the total dollar amount of capital employed would be $1,800,000 (0.12 X $15,000,000). EVA would be negative, and Furman, Inc., would be destroying wealth, not creating it.

**Reference:** Hansen, D.R. & Mowen, M.M. (2011). //Cornerstones of Cost Accounting. // Mason, OH: South-Western, Cengage Learning