The following data pertain to the Whalen Division of Northern Industries. Accounts Title Year...

Question:

The following data pertain to the Whalen Division of Northern Industries.

Accounts Title Year 1 Year 2
Sales 300,000 600,000
Stockholders equity 38,000 400,000
Average operating assets _____ _____
Turnover 6 1.2
Return on investment _____ 9.6%
Minimin required rate of return _____ 7%
Redidual income 16,000 _____

The margin at Whalen was exactly the same in Year 2 as it was in Year 1.

The minimum required rate of return in Year 1 was:

a. 1.92%

b. 32.50%

c. 16.00%

d. 7.58%

Required Rate of Return:

The required rate of return is the minimum return required to meet the cost of the capital structure. In other words, it is the minimum return the company would require to sustain in the business.

Answer and Explanation:


The correct answer to this question is:


Let us first compute the profit margin for year 2 from the given information:

The expanded return on investment(ROI) formula is as follows:

ROI = profit margin * asset turnover

Given ROI = 9.6%

Asset turnover = 1.2

So, profit margin = ROI / asset turnover = 9.6%/1.2 = 8%

It is given that the margin ratio is the same for year 1 and year 2

So, at a profit margin of 8%, net income = net sales * profit margin = $300,000 * 8% = $24,000

Residual income = $16,000

Residual income = net income - (average invested assets * minimum ROI)

Average invested assets * minimum ROI = Net income - residual income

Minimum ROI = (net income - residual income) / average operating assets

Also, Average operating assets = net sales / asset turnover

= $300,000 / 0.6 = $500,000

So, Minimum ROI = ($24,000 - $16,000) / $500,000

Minimum ROI = 16%


Learn more about this topic:

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Required Rate of Return (RRR): Formula & Calculation

from Financial Accounting: Help and Review

Chapter 1 / Lesson 29
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