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Chapter 24: Q23RQ (page 1355)
What is the biggest advantage of using RI to evaluate investment centers?
RI evaluates the division's profitability and how well it employs its average total assets. The goal rate of return set by senior management is also included in RI.
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Consider the following data, and determine which of the corporate divisions is more profitable. Explain your reasoning.
Domestic International
Operating income \( 10,000,000 \) 11,000,000
Average total assets 24,000,000 32,000,000
What does RI measure?
How does capacity affect transfer pricing decisions?
Consider the following condensed financial statements of Forever Free, Inc. The company’s target rate of return is 40%.
Forever Free, Inc | |
Income Statement | |
For the year ended December 31, 2018 | |
Net Sales revenue | \( 3,500,000 |
Cost of Goods Sold | 2,200,000 |
Gross Profit | 1,300,000 |
Operating Expenses | 950,000 |
Operating Income | 350,000 |
Other income and (expenses) | |
Interest Expense | (27,000) |
Income before income tax expense | 323,000 |
Income tax expense | 113,050 |
Net Income | \) 209,950 |
Forever Free, Inc | ||
Income Statement | ||
For the year ended December 31, 2018 | ||
2018 | 2017 | |
Assets | ||
Cash | \( 64,000 | \) 52,000 |
Accounts Receivable | 49,200 | 17,800 |
Supplies | 1,000 | 400 |
Property, Plant, and Equipment, net | 331,800 | 229,800 |
Patents, net | 135,000 | 119,000 |
Total Assets | \( 581,000 | \) 419,000 |
Liabilities and Stockholders’ Equity | ||
Accounts Payable | \( 17,000 | \) 19,000 |
Short-term Notes Payable | 136,000 | 42,000 |
Long-term Notes Payable | 184,000 | 114,500 |
Common Stock, no Par | 232,000 | 242,000 |
Retained Earnings | 12,000 | 1,500 |
Total Liabilities and Stockholders’ Equity | \( 581,000 | \) 419,000 |
Requirements
1. Calculate the company’s ROI. Round all of your answers to four decimal places.
2. Calculate the company’s profit margin ratio. Interpret your results.
3. Calculate the company’s asset turnover ratio. Interpret your results.
4. Use the expanded ROI formula to confirm your results from Requirement 1. Interpret your results.
5. Calculate the company’s RI. Interpret your results.
What is the biggest disadvantage of using ROI to evaluate investment centers?
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