Question

The contribution format income statement for Strickland, Inc., for its most recent period is given below:

		Total		Unit
Sales		$	990,000	$	49.50
Variable expenses			594,000		29.70
Contribution margin			396,000		19.80
Fixed expenses			318,000		15.90
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 $503,000 during the period.

Required:
1.	Compute the company’s return on investment (ROI) for the period using the ROI formula stated in terms of margin and turnover. (Round your intermediate calculations and final answer to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

         

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 original ROI computed in (1) above.

2.	The company achieves a cost savings of $6,000 per period by using less costly materials. (Round your intermediate calculations and Turnover answers to 2 decimal places. Round your Margin and ROI percentage answers to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

         

3.	Using Lean Production, the company is able to reduce the average level of inventory by $91,000. (The released funds are used to pay off bank loans.) (Round your intermediate calculations and Turnover answers to 2 decimal places. Round your Margin and ROI percentage answers to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

         

4.	Sales are increased by $198,000; operating assets remain unchanged. (Round your intermediate calculations and Turnover answers to 2 decimal places. Round your Margin and ROI percentage answers to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

         

5.

The company issues bonds and uses the proceeds to purchase $128,000 in machinery and equipment at the beginning of the period. Interest on the bonds is $14,000 per period. Sales remain unchanged. The new, more efficient equipment reduces production costs by $5,000 per period. (Round your intermediate calculations and Turnover answers to 2 decimal places. Round your Margin and ROI percentage answers to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

         

6.	The company invests $182,000 of cash (received on accounts receivable) in a plot of land that is to be held for possible future use as a plant site. (Round your intermediate calculations and Turnover answers to 2 decimal places. Round your Margin and ROI percentage answers to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

         

7.	Obsolete inventory carried on the books at a cost of $17,000 is scrapped and written off as a loss. (Round your intermediate calculations and Turnover answers to 2 decimal places. Round your Margin and ROI percentage answers to 2 decimal places (i.e., 0.1234 should be entered as 12.34).)

        

Answer 1

Answer to Part 1:

ROI = Margin * Turnover
Margin = Net Operating Income / Sales * 100
Turnover = sales / Average Operating Assets

Margin = 78,000 / 990,000 * 100
Margin = 7.88%

Turnover = 990,000 / 503,000
Turnover = 1.97

ROI = 7.88 * 1.97
ROI = 15.52%

Answer to Part 2:

Cost saving would increase the Net Operating Income by $6,000 and will result in Net Operating Income of $84,000.

Margin = 84,000 / 990,000 * 100
Margin = 8.48%

Turnover = 990,000 / 503,000
Turnover = 1.97

ROI = 8.48 * 1.97
ROI = 16.71%

		Effect
Margin	8.48%	Increase
Turnover	1.97	No Effect
ROI	16.71	Increase

Answer to Part 3:

The reduction of Average Inventory by $91,000 will reduce Average Operating Assets and thereby resulting in Average Operating Assets of $412,000.

Margin = 78,000 / 990,000 * 100
Margin = 7.88%

Turnover = 990,000 / 412,000
Turnover = 2.40

ROI = 7.88 * 2.40
ROI = 18.91%

		Effect
Margin	7.88%	No Effect
Turnover	2.40	Increase
ROI	18.91%	Increase

Answer to Part 4:

The increase in Sales by $198,000 will result in Sales of $1,188,000 and increase the Net Operating Income by increase in Contribution Margin.

Contribution Margin Ratio = 19.80 / 49.50 * 100 = 40%
Increase in Contribution Margin = $198,000 * 40% = $79,200
Increase Net Operating Income = $78,000 + $79,200 = $157,200

Margin = 157,200 / 1,188,000 * 100
Margin = 13.23%

Turnover = 1,188,000 / 503,000
Turnover = 2.36

ROI = 13.23* 2.36
ROI = 31.22%

		Effect
Margin	13.23%	Increase
Turnover	2.36	Increase
ROI	31.22%	Increase