Question

The income statement for Huerra Company for last year is provided below:

			Total			Unit
Sales			$	12,600,000		$	252.00
Less: Variable expenses				10,080,000			201.60
Contribution margin				2,520,000			50.40
Less: Fixed expense				1,260,000			25.20
Net operating income				1,260,000			25.20
Less: Income taxes @ 30%				378,000			7.56
Net income			$	882,000		$	17.64

The company had average operating assets of $6,000,000 during the year.

Required:

1.	Compute the company’s ROI for the period using the ROI formula stated in terms of margin and turnover. (Round intermediate calculation to 2 decimal places. Enter your percentage answer rounded to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)
	ROI%

       

2.	Consider each of the following questions separately and then compute the new ROI figure. Indicate whether the ROI will increase, decrease, or remain unchanged as a result of the events described.

a.	By using JIT, the company is able to reduce the average level of inventory by $300,000. (The released funds are used to pay off short-term creditors.) (Round intermediate calculation to 2 decimal places. Enter your percentage answer rounded to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)
	ROI%

            

b.	The company achieves a savings of $13 per unit by using cheaper materials. (Round intermediate and final answer to 2 decimal places.)
	ROI%

            

c.	The company issues bonds and uses the proceeds to purchase machinery and equipment, thus increasing the average assets by $600,000. Interest on the bonds is $60,000 per year. Sales remain unchanged. The new more efficient equipment reduces fixed production costs by $30,000 per year. (Round intermediate and final answer to 2 decimal places.)
	ROI%

            

d.	As a result of a more intense effort by the sales staff, sales are increased by 20%; operating assets remain unchanged. (Round intermediate and final answer to 2 decimal places.)
	ROI%

            

e.	Obsolete items of inventory carried on the records at a cost of $110,000 are scrapped and sold for 20% of the book value. (Use full amount of scrap while calculating average operating assets. Round intermediate calculation to 2 decimal places. Enter your percentage answer rounded to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)
	ROI%

             

f.

The company uses $600,000 in cash (received on accounts receivable) to repurchase and retire some of its common shares. The net effect of this transaction is a $600,000 change in average operating assets. (Use full amount of scrap while calculating average operating assets. Round intermediate calculation to 2 decimal places. Enter your percentage answer rounded to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

ROI%

            

g.	The company pays a cash dividend to its shareholders, which results in a $600,000 change in average operating assets. (Round intermediate calculation to 2 decimal places. Enter your percentage answer rounded to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)
	ROI%

Answer 1

ANSWER

1. POL - Net operating income Sales Sales Average operating assets $1,260,000 $12,600,000 $12,600,000 $6,000,000 = 10% x 2.1 = 21% 2. ROL = $1,260,000 $12,600,000 = 10% X (Unchanged) $12,600,000 $5,700,000 2.21 (Increase) = 22.10% (Increase) 3. ROL = $1,910,000 $12,600,000 $12,600,000 $6,000,000 = 15.16% X 2.1 (Increase) (Unchanged) = 31.84% (Increase) 4. Interest is a financing expense and thus is not used to compute net Operating income. ROI = BOL - $1,290,000 $12,600,000 $12,600,000 $6,600,000 = 10.24% X 1.91 = 19.56% (Increase) (Decrease) (Decrease) 5. The company has a contribution margin ratio of 20% ($50.40 CM per unit divided by $252 selling price per unit). Therefore, a 20% increase in sales would result in a new net operating income of: Sales(1.2 x $12,600,000)....... $15,120,000 100% Variable expenses................. 12,096,000 80% Contribution margin............. 3,024,000 20% Fixed expenses.... 1,260,000 Net operating income ......... $ 1,764,000

$1,764,000 $15,120,000 $15,120,000 $6,000,000 = 11.67% X 2.52 = 29.41% (Increase) (Increase) (Increase) A change in sales affects both the margin and the turnover. 6. POL $1,172,000 $12,600,000 $12,600,000 $5,912,000 = 9.30% X 2.13 = 19.81% (Decrease) (Increase) (Decrease) 7. ROL = $1,260,000 $12,600,000 = 10% X (Unchanged) 8. ROL = $1,260,000 $12,600,000 10% X (Unchanged) $12,600,000 $5,400,000 2.33 = 23.3% (Increase) (Increase) $12,600,000 $5,400,000 2.33 = 23.3% (Increase) (Increase)

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