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

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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?
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