Mr. Smith is the President of ABC Canada Limited which is a subsidiary of a large multinational firm that is traded on a major stock exchange. The parent company has responsivity for all capital expenditure decisions of the subsidiary and can dictate if the subsidiary must discontinue operations in a market segment and sell the associated assets used in this segment. During 2019 the parent company told the subsidiary that it must discontinue product XYZ and late in 2019 ABC discontinued the production and sales of product XYZ. Specific assets held for disposition and not used in 2020 total have a gross value of $27,778. All entities are evaluated on the return on the assets invested and the required return must be at least 10% in order to earn annual bonuses which are scaled up as the ROI increases above the 10% required return. For purposes of ROI, fixed assets are valued at gross value and not net value. On the next pages, you see condensed summary financial statements for ABC for the year ended December 31, 2020, and a proposed capital expenditure. Financial Statements ABC Canada Limited Balance Sheet as at December 31, 2020 Item $ Current assets $30,000 Non-current assets 70,000 Total assets $100,000 Current liabilities $17,000 Long term debt 50,000 Equity 33,000 Total liabilities and equity $100,000 Idle Assets $27,778 Required return from operations based on total 10% gross assets ABC Canada Limited Income Statement for the year ended December 31, 2020 Item $ Sales $120,000 Cost of sales 77,000 Gross Margin 43,000 Selling and Administrative 30,000 Operating income 13,000 Interest at 6% 3,000 Net Income before tax 10,000 Income tax 3,300 Net income $6,700 Question: Comment on the appropriate return on investment calculation for Mr. Smith and calculate the amount to 1 decimal place.
Mr. Smith is the President of ABC Canada Limited which is a subsidiary of a large multinational firm that is traded on a major stock exchange. The parent company has responsivity for all capital expenditure decisions of the subsidiary and can dictate if the subsidiary must discontinue operations in a market segment and sell the associated assets used in this segment. During 2019 the parent company told the subsidiary that it must discontinue product XYZ and late in 2019 ABC discontinued the production and sales of product XYZ. Specific assets held for disposition and not used in 2020 total have a gross value of $27,778. All entities are evaluated on the return on the assets invested and the required return must be at least 10% in order to earn annual bonuses which are scaled up as the ROI increases above the 10% required return. For purposes of ROI, fixed assets are valued at gross value and not net value. On the next pages, you see condensed summary financial statements for ABC for the year ended December 31, 2020, and a proposed capital expenditure.
Financial Statements
ABC Canada Limited
ABC Canada Limited Income Statement for the year ended December 31, 2020 Item $ Sales $120,000 Cost of sales 77,000 Gross Margin 43,000 Selling and Administrative 30,000 Operating income 13,000 Interest at 6% 3,000 Net Income before tax 10,000 Income tax 3,300 Net income $6,700
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