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UA ACCT 210 - Decentralization and Performance Evaluation II

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ACCT 210 1st Edition Lecture 12Outline of Last Lecture I. Review of in-class activityII. Chapter 10.1: Centralized versus decentralized organizationsIII. Chapter 10.2: Segment evaluationOutline of Current Lecture I. 10.2 continuedII. 10.3: Return on investmentIII. 10.4: Residual income and EVACurrent Lecture1. 10.2 continueda. Segment margin = Revenue – variable costs – traceable fixed costsSegment margin = operating income of that divisionb. Segment margin income statement formatDivision 1 Division 2 TotalRevenue Variable costs$$$$$$Contribution margin Traceable fixed costs$$$$$$Segment margin $ $ $Common fixed costs $Net operating income $2. 10.3: Return on investmenta. Return on investment (ROI) = Operating income ÷ average total assetsi. Expressed as a percentb. Exercise 10-8i. Paula Boothe, president of the Armange Corporation, has mandated a minimum 11% return on investment for any project undertaken by thecompany. Given the company's decentralization, Paula leaves all investment decisions to the divisional managers as long as they anticipatea minimum rate of return of at least 11%. The Energy Drinks division, under the direction of manager Martin Koch, has achieved a 16% return on investment for the past three years. This year is not expected to be different from the past three. Koch has just received a proposal to invest $1,800,000 in a new line of energy drinks that is expected to generate $228,600 in operating income. Calculate the return on investment expected on the new line of energy drinks.ii. ROI = $228,600 ÷ $1,800,000 = 12.7%c. Exercise 10-7bi. Browning Design Works generated $340,000 in operating income on salesrevenue of $2,000,000. The company had $2,093,280 in assets on January1 and $2,890,720 in assets on December 31. Calculate Browning's return on investment.ii. ROI = $340,000 ÷ $ 2,093,280+ $2,890,7202ROI = $ 340,000$ 2,492,000ROI = 13.6%d. Dupont Modeli. Breaks down ROI, giving you relevant informationii. ROI = Margin x Turnoveriii. Margin = Operating incomeSalesrevenueiv. Turnover = SalesrevenueAveragetota l assetse. Exercise 10-9i. Resilon, Inc., reported the following results for last year:LilesDivisionMarstonDivisionOutlandDivisionNet operating income $ 114,000 $ 48,000 $ 264,000Sales revenue 600,000 150,000 1,200,000Average operating assets 1,023,000 300,000 1,517,000Which division generates the highest margin?ii. Liles’ margin = $114,000 ÷ $600,000 = 19%Marston = $48,000 ÷ $150,000 = 32%Outland = $264,000 ÷ $1,200,000 = 22%Marston generated the highest margin3. 10.4: Residual income and EVAa. Residual incomei. Income earned above a minimum level of return ii. Residual income = Operating income – (average assets x require minimumrate of return)b. Exercise 10-14i. Colleen Barry is the general manager of Whitten Industries' Industrial Products division. The division is treated as an investment center, and Colleen's performance is measured using residual income. In preparing the forecast for next year, Colleen assumes the division will generate $30,130,000 in revenue using average operating assets of $19,172,000. The required minimum rate of return is 16%. If Colleen wants the division to achieve $1,980,700 in residual income, what is the maximumamount of operating expenses the division can incur to achieve that target?ii. Residual income = OI – (avg assets x required minimum rate)Residual income = (Revenue – expenses) – (avg assets x req rate)$1,980,700 = ($30,130,000 – x) – ($19,172,000 x 16%)$1,980,700 = $30,130,000 – x – $3,067,520$1,980,700 = $27,062,480 – xx = $27,062,480 - $1,980,700Maximum operating expenses = $25,081,780c. Economic value added (EVA)i. Variation of residul income that measures economic profictii. EVA = Net operating profit – (invested capital x WACC)iii. Net operating income = Operating income – income taxesiv. Invested capital = Total assets – current liabilitiesd. Exercise 10-15i. Lewiston Industries finances its operations with $50,000,000 in debt and $100,000,000 in stockholders' equity. The debt carries a 8% interest rate, and stockholders require a 14% return. What is Lewiston's weighted‐average cost of capital?ii. Debt = $ 50,000,000$ 50,000,000+ $100,000,000 x 8% = 2.67%Equity = $ 100,000,000$ 50,000,000+ $100,000,000 x 14% = 9.33%WACC = 2.67% + 9.33%WACC = 12%e. Exercise 10-16i. Paula Boothe, president of the Armange Corporation, has mandated a minimum 10% return on investment for any project undertaken by the company. Given the company's decentralization, Paula leaves all investment decisions to the divisional managers as long as they anticipate a minimumrate of return of at least 10%. The Energy Drinks division, under the direction of manager Martin Koch, has achieved a 16% return on investment for the past three years. This year is not expected to be different from the past three. Koch has just received a proposal to invest $1,844,000 in a new line of energy drinks that is expected to generate $237,900 in operating income. Assume that Armange Corporation's actualweighted average cost of capital is 8% and its tax rate is 32%. ‐ Calculate the economic value added of the proposed new line of energy drinks.ii. Net operating income = $237,900 * 0.64 = $152,064WACC = 8%Invested capital = $1,844,000EVA = Net operating income – (invested capital x WACC)EVA = $152,064 – ($1,844,000 x 8%)EVA = $152,064 - $147,520EVA =


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UA ACCT 210 - Decentralization and Performance Evaluation II

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