Question

Financial data for Stirling Inc. for last year are as follows:

Stirling, Inc. Balance Sheet
Beginning Balance Ending Balance
Assets
Cash $ 139,000 $ 136,000
Accounts receivable 334,000 478,000
Inventory 563,000 478,000
Plant and equipment, net 874,000 858,000
Investment in Brier Company 405,000 429,000
Land (undeveloped) 246,000 250,000
Total assets $ 2,561,000 $ 2,629,000
Liabilities and Stockholders' Equity
Accounts payable $ 381,000 $ 339,000
Long-term debt 974,000 974,000
Stockholders' equity 1,206,000 1,316,000
Total liabilities and
stockholders' equity $ 2,561,000 $ 2,629,000
Stirling Inc.
Income Statement
Sales $5,404,000
Operating expenses 4,755,520
Net operating income 648,480
Interest and taxes:
Interest expense $130,000
Tax expense 192,000 322,000
Net income $326,480
The company paid dividends of $216,480 last year.
The "Investment in Brier Company" on the balance sheet represents an investment in the stock of another company.
Required:
1. Compute the company's margin, turnover and return on investment (ROI) for last year.
(Do not round intermediate calculations. Round Turnover answer to 2 decimal places. Round Margin and ROI % answers to 2 decimal places)
2. The board of directors of Stirling Inc. has set a minimum required return of 15%.
What was the company's residual income last year?

Answer 1

profit margin: 6.04%

Assets turnover: 2.08

ROI 25.89%

Residual Income 137,330

Step-by-step explanation:

profit margin:

income/sales = 326,480/5,404,000 = 0.060414507 = 6.0414507%

Assets turnover:

`(net \: sales)/(average \: assets) \\\\where:\\average \: assets = (ending + beginning)/(2)`

(2,561,000 + 2,629,000)/2 = 2,595,000 average assets

5,404,000/2,595,000 = 2.082466281 Assets TO

ROI

`(net \: income)/(average \: equity) \\\\where:\\average \: equity= (ending + beginning)/(2)`

(1,206,000+1,316,000)/2 = 1,261,000 average equity

326,480/1,261,000 = 25.890563%

Residual Income:

current income - income at desired RoR

That means calculate which income generates a ROI of 15% which is the minimum required return:

ROI = income / equity = 0.15

X/1,261,000 = 0.15

X=1,261,000 x 0.15 = 189,150

Now we calculate the diference between this number and the current income.

326,480 - 189,150 = 137,330 Residual Income