Question

Exercise 23-17 The South Division of Wiig Company reported the following data for the current year. Sales Variable costs Controllable fixed costs Average operating assets $3,000,000 2,010,000 605,000 5,000,000 Top management is unhappy with the investment center's return on investment (ROI). It asks the manager of the South Division to submit plans to improve ROI in the next year. The manager believes it is feasible to consider the following independent courses of action. 1. Increase sales by $300,000 with no change in the contribution margin percentage. 2. Reduce variable costs by $155,000. 3. Reduce average operating assets by 3%. (a) Compute the return on investment (ROI) for the current year. (Round ROI to 2 decimal places, e.g. 1.57%) Return on Investment (b) Using the ROI formula, compute the ROI under each of the proposed courses of action. (Round ROI to 2 decimal places, e.g. 1.57%.) Return on investment Action 1 Action 2 Action 3

Answer 1

a.

ROI = (Profit / Average operating assets) × 100

Hence,

Profit = Sales – Variable cost – Fixed cost

            = 3,000,000 – 2,010,000 – 605,000

            = 385,000

Therefore,

ROI = (385,000 / 5,000,000) × 100

            = 7.70% (Answer)

b.

Action 1:

Current contribution margin percentage = [(Sales – Variable cost) / Sales] × 100

                                                                 = [(3,000,000 – 2,010,000) / 3,000,000] × 100

                                                                 = [990,000 / 3,000,000] × 100

                                                                 = 33%

Such percentage will remain the same in this action but sale increases to (3,000,000 + 300,000 =) 3,300,000.

Hence the new variable cost would be solved as below:

Current contribution margin percentage = [(Sales – Variable cost) / Sales] × 100

0.33 = [(3,300,000 – Variable cost) / 3,300,000] × 100

33% × 3,300,000 = 3,300,000 – Variable cost

1,089,000 – 3,300,000 = - variable cost

Variable cost = 2,211,000

Hence,

Profit = Sales – Variable cost – Fixed cost

            = 3,300,000 – 2,211,000 – 605,000

            = 484,000

Therefore,

ROI = (484,000 / 5,000,000) × 100

            = 9.68% (Answer)

Action 2:

Variable cost would become (2,010,000 – 155,000 =) 1,855,000.

Hence,

Profit = Sales – Variable cost – Fixed cost

            = 3,000,000 – 1,855,000 – 605,000

            = 540,000

Therefore,

ROI = (540,000 / 5,000,000) × 100

            = 10.80% (Answer)

Action 3:

Average operating assets would become [5,000,000 × (1 – 0.03) = 5,000,000 × 0.97 =] 4,850,000.

Hence,

Profit = Sales – Variable cost – Fixed cost

            = 3,000,000 – 2,010,000 – 605,000

            = 385,000

Therefore,

ROI = (385,000 / 4,850,000) × 100

            = 7.94% (Answer)