MBA560 Financial and Managerial Accounting: Module 8 Homework (P15-22 and P16-18)

Reminder: Please make sure to reword or paraphrase written essay answers; do not submit our tutorial as your own work. MBA560 Financial and Managerial Accounting Module 8 Homework (P15-22 and P16-18) Problem 15-22 Comparing return on investment and residual income Wells Corporation operates three investment centers. The following financial statements apply to the investment center named Huber Division. HUBER DIVISION Income Statement For the Year Ended December 31, 2011 Sales revenue 105,480 Cost of goods sold (60,275) Gross margin 45,205 Operating expenses Selling expenses (2,840) Depreciation expense (4,205) Operating income 38,160 Nonoperating item Gain of sale of land (5,000) Net income 33,160 HUBER DIVISION Balance Sheet As of December 31, 2011 Assets Cash 12,472 Accounts receivable 40,266 Merchandise inventory 36,000 Equipment less accum. dep. 90,258 Nonoperating assets 9,000 Total assets 187,996 Liabilities Accounts payable 9,637 Notes payable 72,000 Stockholders’ equity Common stock 80,000 Retained earnings 26,359 Total liab. and stk. Equity 187,996 Required a. Which should be used to determine the rate of return (ROI) for the Huber investment center, operating income or net income? Explain your answer. b. Which should be used to determine the ROI for the Huber investment center, operating assets or total assets? Explain your answer. c. Calculate the ROI for Huber. d. Wells has a desired ROI of 15 percent. Headquarters has $96,000 of funds to assign to its investment centers. The manager of the Huber Division has an opportunity to invest the funds at an ROI of 17 percent. The other two divisions have investment opportunities that yield only 16 percent. Even so, the manager of Huber rejects the additional funding. Explain why the manager of Huber would reject the funds under these circumstances. e. Explain how residual income could be used to encourage the manager to accept the additional funds. Problem 16-18 Using net present value and internal rate of return to evaluate investment opportunities Veronica Tanner, the president of Tanner Enterprises, is considering two investment opportunities. Because of limited resources, she will be able to invest in only one of them. Project A is to purchase a machine that will enable factory automation; the machine is expected to have a useful life of four years and no salvage value. Project B supports a training program that will improve the skills of employees operating the current equipment. Initial cash expenditures for Project A are $100,000 and for Project B are $40,000. The annual expected cash inflows are $31,487 for Project A and $13,169 for Project B. Both investments are expected to provide cash flow benefits for the next four years. Tanner Enterprise’s cost of capital is 8 percent. Required a. Compute the net present value of each project. Which project should be adopted based on the net present value approach? b. Compute the approximate internal rate of return of each project. Which one should be adopted based on the internal rate of return approach? c. Compare the net present value approach with the internal rate of return approach. Which method is better in the given circumstances? Why?