The income statement for Huerra Company for last year is provided below: |
Total | Unit | |||||||
Sales | $ | 15,400,000 | $ | 154.00 | ||||
Less: Variable expenses | 12,320,000 | 123.20 | ||||||
Contribution margin | 3,080,000 | 30.80 | ||||||
Less: Fixed expense | 1,540,000 | 15.40 | ||||||
Net operating income | 1,540,000 | 15.40 | ||||||
Less: Income taxes @ 30% | 462,000 | 4.62 | ||||||
Net income | $ | 1,078,000 | $ | 10.78 | ||||
The company had average operating assets of $14,000,000 during the year. |
Required: |
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. | |
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.) |
d. | |
e. |
Obsolete items of inventory carried on the records at a cost of $80,000 are scrapped and sold for 25% 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).) |
f. |
The company uses $200,000 in cash (received on accounts receivable) to repurchase and retire some of its common shares. The net effect of this transaction is a $200,000 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).) |
g. | |
Ans.
RO I = Net operating income /Sales * Sales /Average operating assets
ROI = $ 1,540,000 / $ 15,400,000 * $ 15,400,000/ $ 14,000,000
ROI = 10% * 1.1 = 11%
c)
RO I = Net operating income /Sales * Sales /Average operating asset
ROI = ($1,540,000 + $ 30,000 ) / $ 15,400,000 * $ 15,400,000 / ($ 14,000,000 + $ 600,000)
ROI = $ 1,570,000 / $ 15,400,000 * $ 15,400,000/ $ 14,600,000
ROI = 10.195 % * 1.05479 = 10.75 %
Note : Interest is a financing expense and thus it is not used to compute net operating income
The company issues bonds and uses the proceeds to purchase machinery and equipment at the beginning of the period has increased the margin and decreased the turnover and ROI.
e)
RO I = Net operating income /Sales * Sales /Average operating asset
ROI = ($1,540,000 - $ 60,000 ) / $ 15,400,000 * $ 15,400,000 / ($ 14,000,000 - $ 80,000)
ROI = $ 1,480,000 / $ 15,400,000 * $ 15,400,000/ $ 13,920,000
ROI = 9.61 % * 1.1063 = 10.63%
Inventory treated as scrap will decrease the net operating income by $ 60,000 ( $ 80,000 - ( $ 80,000 * 25 %) and average operating assets by $80,000 ( given in question) .The Margin has decreased and turnover has increased and ROI is increased.
f)
RO I = Net operating income /Sales * Sales /Average operating asset
ROI = $ 1,540,000 / $ 15,400,000 * $ 15,400,000 / ($ 14,000,000 - $ 200,000)
ROI = $ 1,540,000 / $ 15,400,000 * $ 15,400,000 / $ 13,800,000
ROI = 10% * 1.11594 = 11.1594% or 11.16 %
The company uses cash so average operating assets are reduced by $200,000.Margin remains same.Turnover and ROI has increased .
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