Question

The South Division of Wiig Company reported the following data for the current year. Sales $2,950,000 Variable costs 1,947,000 Controllable fixed costs 605,000 Average operating assets 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 $160,000. 3. Reduce average operating assets by 4%.

(a) Compute the return on investment (ROI) for the current year. (Round ROI to 2 decimal places, e.g. 1.57%.)

(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		Enter percentages	%
Action 2		Enter percentages	%
Action 3		Enter percentages	%

Answer 1

(a). Calculate return on investment (ROI) for the current year as follows: Particulars Sales Less: Variable cost Contribution Contribution margin ratio Less: Fixed cost Controllable margin (a) Average operating assets (b) Return on Investment (a) = (b) Amount $2,950,000 $1,947,000 $1,003,000 $ 0.34 $ 605.000 $ 398,000 $5,000,000 7.96% Hence, return on investment (ROI) for the current year is 7.96% (b). Action 1 Calculate the new ROI if the sales increase by $ 300,000, but contribution margin remains the same: B Particulars 2 Sales 3 Less: Variable cost 4 Contribution 5 Contribution margin ratio 6 Less: Fixed cost 7 Controllable margin (a) 8 Average operating assets (b) 9 Return on Investment (a) = (b) Amount $3,250.000 $2,145,000 $1,105,000 $ 0.34 $ 605,000 $ 500.000 $5,000,000 10.00% Hence, the new return on investment (ROI) for the current year is 10.00% Working note: B 1 Particulars Amount 2 Sales =2950000+300000 3 Less: Variable cost =(1-B5)*B2 4 Contribution =B5*B2 5 Contribution margin ratio =0.34 6 Less: Fixed cost 605000 7 Controllable margin (a) =B4-B6 8 Average operating assets (6) 5000000 9 Return on Investment (a) - (b) =B7/B8

Action 2 Calculate the new ROI if the variable cost is reduced by $ 160,000 B 1 Particulars 2 Sales 3 Less: Variable cost 4 Contribution 5 Contribution margin ratio 6 Less: Fixed cost 7 Controllable margin (a) 8 Average operating assets (b) 9 Return on Investment (a) - (b) Amount $2,950,000 $1,787,000 $1,163,000 $ 0.39 $ 605,000 $ 558,000 $5,000,000 11.16% Hence, the new ROI if the variable cost is reduced by $ 160,000 is 11.16% Working note: B Particulars Amount 2 Sales 2950000 3 Less: Variable cost =1947000-160000 4 Contribution =B2-B3 5 Contribution margin ratio =B4/B2 6 Less: Fixed cost 605000 7 Controllable margin (a) =B4-B6 8 Average operating assets (6) 5000000 9 Return on Investment (a) = (b) =B7/B8

Action 3 Calculate the new ROI if the average operating assets reduce by 4% B 1 Particulars 2 Sales 3 Less: Variable cost 4 Contribution 5 Contribution margin ratio 6 Less: Fixed cost 7 Controllable margin (a) 8 Average operating assets (b) 9 Return on Investment (a) - (b) Amount $2,950,000 $1,947,000 $1,003,000 $ 0.34 $ 605,000 $ 398,000 $4,800,000 8.29% Hence, the new ROI if the average operating assets reduce by 4% is 8.29% Working note: Particulars Amount 2 Sales 2950000 3 Less: Variable cost 1947000 4 Contribution =B2-B3 5 Contribution margin ratio =B4/B2 6 Less: Fixed cost 605000 7 Controllable margin (a) =B4-B6 8 Average operating assets (b) =5000000-4%*5000000 9 Return on Investment (a) = (b) =B7/B8