Question

The contribution format income statement for Huecia Company for last year is given below: Unit Sales Variable expenses Contribution margin Fixed expenses Net operating income Income taxes @ 30% Net operating income Total $4,000,000 2,800,000 1,200,000 840,000 360,000 108,000 $ 252,000 $80.00 56.00 24.00 16.80 7.20 2.16 $ 5.04 The company had average operating assets of $2,000,000 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. Consider each question separately (independently), 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 $400,000. Sales and profits will remain the same. (The released funds are used to pay off short-term creditors.) 3. The company achieves a cost savings of $32,000 per year by using less costly materials. 4. The company reduces fixed expenses by $100,000 by cutting advertising. This results in a 10% reduction in sales. Assets remain unchanged. 5. As a result of a more intense effort by salespeople, sales are increased by 20%; fixed costs and operating assets remain unchanged. 6. Obsolete inventory carried on the books at a cost of $40,000 is scrapped and written off as a loss. 7. The company uses $200,000 of cash (received on accounts receivable) to repurchase and retire some of its common stock.

Answer 1

Answer

Given data Sales Variable cost Contribution margin Fixed expenses Net operating income Income Tax@ 30% Net Income Average Operating assets $ $ $ $ $ $ $ $ 4,000,000 2,800,000 1,200,000 840,000 360,000 108,000 252,000 2,000,000 Rate of return (ROI) = Profit margin x Asset turnover 1 Rate of return (ROI). Sales Net operating income Average Operating assets $ $ $ 4,000,000 360,000 2,000,000 Particulars Value Profit margin = (Net operating income/Sales) Asset turn over =(Sales/Average operating assets) Rate of return (ROI) = Profit margin x Asset turnover 9.00% 2 18.00% 2 Average Inventory reduces by 4000000 If average Inventory reduces by 4000000, Average Operating assets will reduce by 4000000 Sales $ 4,000,000 Net operating income $ 360,000 Average Operating assets $ 1,600,000 =2000000-400000 Particulars Value Profit margin = (Net operating income/Sales) Asset turn over =(Sales/Average operating assets) Rate of return (ROI) = Profit margin x Asset turnover Effect 9.00% Unchanged 2.5 Increase 22.50% Increase

3 Cost Saving of 32000 Net operating income will increase by 32000 Sales Net operating income Average Operating assets $ $ $ 4,000,000 392,000 =360000+32000 2,000,000 Particulars Value Profit margin = (Net operating income/Sales) Asset turn over =(Sales/Average operating assets) Rate of return (ROI) = Profit margin x Asset turnover Effect 9.80% Increase 2 Unchanged 19.60% Increase 4 Fixed Cost reduce by 1000000, Reduction in Sale 10% Sales Less: Variable cost Contribution margin Less: Fixed expenses Net operating income Average Operating assets $ $ $ $ $ $ 3,600,000 -4000000-90% (2,520,000) =2800000-90% 1,080,000 (840,000) 240,000 2,000,000 Particulars Value Profit margin = (Net operating income/Sales) Asset turn over =(Sales/Average operating assets) Rate of return (ROI) = Profit margin x Asset turnover Effect 6.67% Decrease 1.8 Decrease 12.00% Decrease 5 Sales Increase by 20% Sale will increase and contribution and thus net operating income will also increase Sales $ 4,800,000 -4000000*120% Less: Variable cost $ (3,360,000) =2800000*120% Contribution margin $ 1,440,000 Less: Fixed expenses $ (840,000) Net operating income $ 600,000 Average Operating assets $ 2,000,000 Effect Particulars Value Profit margin = (Net operating income/Sales) Asset turn over =(Sales/Average operating assets) Rate of return (ROI) = Profit margin x Asset turnover 12.50% increase 2.4 increase 30.00% Increase

6 Obsolete inventory of 200000 scrapped and written off Net operating income will decrease by 40000 and Average Operating assets will decrease by 40000 Sales $ 4,000,000 Net operating income $ 320,000 =360000-40000 Average Operating assets $ 1,960,000=2000000-40000 Value Particulars Profit margin = (Net operating income/Sales) Asset turn over =(Sales/Average operating assets) Return on Investment (ROI) = Profit margin x Asset Effect 8.00% Decrease 2.04 Increase 16.33% Decrease 7 Cash of 200000 used to retire Common Stock Average Operating assets will decrease by 200000 Sales Net operating income Average Operating assets $ $ $ 4,000,000 360,000 1,800,000=2000000-200000 Particulars Value Profit margin = (Net operating income/Sales) Asset turn over =(Sales/Average operating assets) Return on Investment (ROI) = Profit margin x Assett Effect 9.00% Unchanged 2.22 increase 20.00% increase

..