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Exercise 14-32 Compare Current Cost to Historical Cost (LO 14-2, 5)

The Caribbean Division of Mega-Entertainment Corporation just started operations. It purchased depreciable assets costing $25 million and having a four-year expected life, after which the assets can be salvaged for $5 million. In addition, the division has $25 million in assets that are not depreciable. After four years, the division will have $25 million available from these non-depreciable assets. This means that the division has invested $50 million in assets with a salvage value of $30 million. Annual depreciation is $5 million. Annual operating cash flows are $12.5 million. In computing ROI, this division uses end-of-year asset values in the denominator. Depreciation is computed on a straight-line basis, recognizing the salvage values noted. Ignore taxes. Assume that all cash flows increase 10 percent at the end of each year. This has the following effect on the assets' replacement cost and annual cash flows:
End of Year Replacement Cost Annual Cash Flow
1 $ 50,000,000 × 1.1 = $ 55,000,000 $ 12,500,000 × 1.1 = $ 13,750,000
2 $ 55,000,000 × 1.1 = $ 60,500,000 $ 13,750,000 × 1.1 = $ 15,125,000
3 Etc. Etc.
4
Depreciation is as follows:
Year For the Year "Accumulated"
1 $ 5,500,000 $ 5,500,000 (= 10% × $55,000,000)
2 6,050,000 12,100,000 (= 20% × 60,500,000)
3 6,655,000 19,965,000
4 7,320,500 29,282,000

Note that "accumulated" depreciation is 10 percent of the gross book value of depreciable assets after one year, 20 percent after two years, and so forth.
Required:
(a)

Compute ROI using historical cost, net book value and gross book value. (Do not round intermediate calculations. Round your answers to 1 decimal place.)

(b)

Compute ROI using current cost, net book value and gross book value. (Do not round intermediate calculations. Round your answers to 1 decimal place.)

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Nelly Stracke
Nelly StrackeLv2
30 Sep 2019

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At the beginning of 2009, Metatec inc. acquired EllsionTechnology Corp for $600 million. In addition to cash, receivables,and inventory , the following asssets and their fair values werealso inquired.

plant and Equipment(Depreciable Assets) 150 million

Patent 40 million

goodwill 100 million

The plant and equipment are depreciated over a 10 year usefullife on a straight line basis. There is no estiamted residualvalue. The patent is estimated to have a 5 year useful life, noresidual value, and is amortized using straightline method.

At the end of 2011 a change in business climate indicated tomanagement that the assets of Ellison might be impaired. Thefollowing amounts have been determined.

Plant & equip.

Undiscovered Sum of future cash flows 80 Million

Fair Value 60 Million

Patent:

Undiscovered sum of future cash flows 20 Million

Fair value 13 Million

Goodwill:

Fair value of Ellison Tech 450 Million

Fair Value of Ellisons net Assets (excluding goodwill) 390Million

Book Value of Ellison net assets ( including goodwill) 470Million- this is after first recording any impairment losses onplant and equipment and the patent.

Required

1.Compute the book value of the plant and equipment and patentat the end of 2011.

2. When should the plant and equipment and the patent be testedfor impairment

3. When should goodwill be tested for impairment

4. Determine the amount of any impairment loss to be recorded ifany for the three assets.

Effect of Proposals on Divisional Performance

A condensed income statement for the Golf Division of RewindSports Inc. for the year ended December 31, 2016, is asfollows:

Sales $3,360,000
Cost of goods sold 2,408,800
Gross profit $ 951,200
Operating expenses 548,000
Income from operations $ 403,200
Invested assets $2,400,000

Assume that the Golf Division received no charges from servicedepartments. The president of Rewind Sports has indicated that thedivision's rate of return on a $2,400,000 investment must beincreased to at least 20.4% by the end of the next year ifoperations are to continue. The division manager is considering thefollowing three proposals:

Proposal 1: Transfer equipment with a book value of$480,000 to other divisions at no gain or loss and lease similarequipment. The annual lease payments would exceed the amount ofdepreciation expense on the old equipment by $86,400. This increasein expense would be included as part of the cost of goods sold.Sales would remain unchanged.

Proposal 2: Purchase new and more efficient machiningequipment and thereby reduce the cost of goods sold by $316,800after considering the effects of depreciation expense on the newequipment. Sales would remain unchanged, and the old equipment,which has no remaining book value, would be scrapped at no gain orloss. The new equipment would increase invested assets by anadditional $1,200,000 for the year.

Proposal 3: Reduce invested assets by discontinuing aproduct line. This action would eliminate sales of $510,000, costof goods sold of $340,800, and operating expenses of $150,000.Assets of $1,215,100 would be transferred to other divisions at nogain or loss.

Required:

1. Using the DuPont formula for rate of returnon investment, determine the profit margin, investment turnover,and rate of return on investment for the Golf Division for the pastyear. Round your answers to one decimal place.

Golf Division
Profit margin %
Investment turnover
ROI %

2. Prepare condensed estimated incomestatements and compute the invested assets for each proposal.

Rewind SportsInc.-Golf Division
EstimatedIncome Statements
For the YearEnded December 31, 2016
Proposal 1 Proposal 2 Proposal 3
Sales $ $ $
Cost of goods sold
Gross profit $ $ $
Operating expenses
Income from operations $ $ $
Invested assets $ $ $

3. Using the DuPont formula for rate of returnon investment, determine the profit margin, investment turnover,and rate of return on investment for each proposal. Round youranswers to one decimal place.

Profit Margin Investment Turnover ROI
Proposal 1 % %
Proposal 2 % %
Proposal 3 % %

4. Select whether each of the three proposalswould meet the required 20.4% rate of return on investment.

Proposal 1
Proposal 2
Proposal 3

5. If the Golf Division were in an industrywhere the profit margin could not be increased, how much would theinvestment turnover have to increase to meet the president'srequired 20.4% rate of return on investment? Enter your increase ininvestment turnover answer as a percentage of current investmentturnover. If required, round your answer to one decimal place.

A condensed income statement for the Commercial Division ofMaxell Manufacturing Inc. for the year ended December 31, 2016, isas follows:

1

Sales

$3,850,000.00

2

Cost of goods sold

2,670,000.00

3

Gross profit

$1,180,000.00

4

Operating expenses

795,000.00

5

Income from operations

$385,000.00

6

Invested assets

$2,750,000.00

Assume that the Commercial Division received no charges fromservice departments. The president of Maxell Manufacturing hasindicated that the division’s rate of return on a $2,750,000investment must be increased to at least 18.00% by the end of thenext year if operations are to continue. The division manager isconsidering the following three proposals:

Proposal 1: Transfer equipment with a book value of$315,000 to other divisions at no gain or loss and lease similarequipment. The annual lease payments would exceed the amount ofdepreciation expense on the old equipment by $108,000. Thisincrease in expense would be included as part of the cost of goodssold. Sales would remain unchanged.

Proposal 2: Purchase new and more efficient machiningequipment and thereby reduce the cost of goods sold by $525,000after considering the effects of depreciation expense on the newequipment. Sales would remain unchanged, and the old equipment,which has no remaining book value, would be scrapped at no gain orloss. The new equipment would increase invested assets by anadditional $1,818,000 for the year.

Proposal 3: Reduce invested assets by discontinuing aproduct line. This action would eliminate sales of $594,000, reducecost of goods sold by $407,700, and reduce operating expenses by$178,500. Assets of $1,388,000 would be transferred to otherdivisions at no gain or loss.

Required:
1. Using the DuPont formula forrate of return on investment, determine the profit margin,investment turnover, and rate of return on investment for theCommercial Division for the past year.*
2. Prepare condensed estimatedincome statements and compute the invested assets for eachproposal.
3. Using the DuPont formula forrate of return on investment, determine the profit margin,investment turnover, and rate of return on investment for eachproposal.*
4. Which of the three proposalswould meet the required 18.00% rate of return oninvestment?
5. If the Commercial Division werein an industry where the profit margin could not be increased, howmuch would the investment turnover have to increase to meet thepresident’s required 18.00% rate of return on investment? Enteryour increase in investment turnover answer as a percentage ofcurrent investment turnover. Do not round interimcalculations.

* If required, round your answers to one decimalplace.

1. Using the DuPont formula for rate of return on investment,determine the profit margin, investment turnover, and rate ofreturn on investment for the Commercial Division for the past year.If required, round your answers to one decimal place.

Commercial Division
Profit margin %
Investment turnover
ROI

%

2. Prepare condensed estimated income statements and compute theinvested assets for each proposal.

MAXELL MANUFACTURING INC.—COMMERCIAL DIVISION

Estimated Income Statements

For the Year Ended December 31, 2016

1

Proposal 1

Proposal 2

Proposal 3

2

Sales

3

Cost of goods sold

4

Gross profit

5

Operating expenses

6

Income from operations

7

Invested assets

3. Using the DuPont formula for rate of return on investment,determine the profit margin, investment turnover, and rate ofreturn on investment for each proposal. (Note: Ifrequired, round your intermediate and final answers to two decimalplaces.)

Profit Margin Investment Turnover ROI
Proposal 1 % %
Proposal 2 % %
Proposal 3 % %

5. If the Commercial Division were in an industry where theprofit margin could not be increased, how much would the investmentturnover have to increase to meet the president’s required 18.00%rate of return on investment? Enter your increase in investmentturnover answer as a percentage of current investment turnover.(Note: If required, round your intermediate andfinal answers to two decimal places.)

%

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