Question

The contribution format income statement for Huerra Company for last year is given below:

	Total		Unit
Sales	$	992,000	$	49.60
Variable expenses		595,200		29.76
Contribution margin		396,800		19.84
Fixed expenses		318,800		15.94
Net operating income		78,000		3.90
Income taxes @ 40%		31,200		1.56
Net income	$	46,800	$	2.34

The company had average operating assets of $499,000 during the year.

Required:

1. Compute the company’s return on investment (ROI) for the period using the ROI formula stated in terms of margin and turnover.

For each of the following questions, indicate whether the margin and turnover will increase, decrease, or remain unchanged as a result of the events described, and then compute the new ROI figure. Consider each question separately, starting in each case from the data used to compute the original ROI in (1) above.

2. Using Lean Production, the company is able to reduce the average level of inventory by $107,000. (The released funds are used to pay off short-term creditors.)

3. The company achieves a cost savings of $7,000 per year by using less costly materials.

4. The company issues bonds and uses the proceeds to purchase machinery and equipment that increases average operating assets by $126,000. Interest on the bonds is $13,000 per year. Sales remain unchanged. The new, more efficient equipment reduces production costs by $6,000 per year.

5. As a result of a more intense effort by salespeople, sales are increased by 15%; operating assets remain unchanged.

6. At the beginning of the year, obsolete inventory carried on the books at a cost of $17,000 is scrapped and written off as a loss.

7. At the beginning of the year, the company uses $175,000 of cash (received on accounts receivable) to repurchase and retire some of its common stock.

Answer 1

Total Unit Sales 992000 49.60 Varaible Expenses Contribution Margin Fixed Expenses 595200 29.76 396800 19.84 318800 15.94 Net operating income 78000 3.90 1.56 Income Tax 40% 31200 Net income 46800 2.34 499000 Average operating Assets Companie's ROI sales 992000 Net Operating income (NOI) 78000 Operating Assets 499000 Margin (NOI/ Sales) Turnover (Sales Operating Assets) ROI (NOI/ Operating Assets) 7.86% 1.99 15.63%

IF Firm Reduce the Average level of inventory BY 107000 Average Assets = 392000 sales 992000 Net Operating income (NOI) 78000 Operating Assets 392000 Effect 7.86% Un Changed 2.53 Increase Margin= (NO1/ Sales) Turnover (Sales / Operating Assets) ROI (NOI/ Operating Assets) 19.90% Increase 3) Cost Saving by 7000 sales 992000 Net Operating income (NOI) 85000 Operating Assets 499000 Effect 8.57% Increase 1.99 Unchnage 17.03% Increase Margin= (NO1/ Sales) Turnover Sales Operating Assets) ROI NOI/ Operating Assets)

4) IF the Firm issue a bond $126,000 Prodcution Cost will Reduce by 6000 126000 Bond issue Cost saving 6000 sales 992000 Net Operating income (NOI) Operating Assets 84000 625000 Effect 8.47%Increase 1.59 Decrease 13.44% Decrease Margin= (NO1/Sales) Turnover=(Sales /Operating Assets) ROI (NOI/ Operating Assets) 5) Sales Increase by 15% 15% 1140800 Sales 456320 increase in contibtion Margin Fixed cost 318800 137520 Netoperating income Operating Assets 499000 Effect 12.05% Increase 2.29 Increase 27.56% Increase Margin= (NOI/Sales) Turnover (Sales /Operating Assets) ROI (NOI/ Operating Assets)

Obsolete inventory Carried on the at a cost of $17000 Obsolete inventory 6) 17000 sales 992000 Net Operating income (NOI) Operating Assets 61000 482000 Effect Margin= (NOI/ Sales) Turnover -(Sales /Operating Assets) ROI (NOI/ Operating Assets) 6.15% Decrease 2.06 Increase 12.66% Decreased Use Cash for Retire Common Stock 7) Retire Common Stock 175000 sales 992000 Net Operating income (NOI) Operating Assets 78000 324000 Effect Margin= (NOI/ Sales) Turnover=(Sales / Operating Assets) ROI (NOI/ Operating Assets) 7.86% Unchanged 3.06 Increase 24.07% Increase