Question

Problem 10-20 Return on Investment (ROI) Analysis [L010-1 The contribution format income statement for Huerra Company for last year is given below 992,000 49.60 Variable expenses Contribution margin 595,200 396,800 84,000 50,400 19.84 312,800 15.64 4.20 Set operating ineome Income taxes e 40 Net isone 2.52 The company had average operating assets of $503,000 during the year Required 1. Compute the company's return on Investment (RO) for the perlod using the ROI formula stated in terms of margin and turnover For each of the followling questions, indicate whether the margin and turnover will Increase, decrease, or remain unchanged as a resu of the events described, and then compute the new ROl figure. Consider each question separately, starting in each case fromr the data used to compute the original ROI in (0 above. 2. 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 short-term cred tors.) 3. The company achieves a cost savings of $14,000 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 $123,000. Interest on the bonds is $15,000 per year. Sales remain unchanged. The new, more efficient equipment reduces production costs by $5,000 per year 5. As a result of a more intense effort by salespeople, sales are increased by 25% 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 3 5 8

Answer 1

Margin Formula = (Net Operating Income / Sales)*100

Investment Turnover = Sales / Average Operating Assets

ROI = Margin * Investment Turnover

1)

Margin = ($84000/$992000)*100 = 8.46%

Investment Turnover = $992000/$503000 = 1.97

ROI = 8.46% * 1.97 = 16.66%

2) If Average Operating Assets Reduce by $91000.

New Average Operating Assets = $503000 - $91000 = $412000

Margin = ($84000/$992000)*100 = 8.46% Unchanged

Investment Turnover = $992000 / $412000 = 2.40 Increase

ROI = 8.46% * 2.40 = 20.30% Increase

3) If Cost Savings of $14000 per year by using less costly Mateials.

New Operating Income = $84000 + $14000 = $98000

Margin = ($98000/$992000)*100 = 9.88% Increase

Investment Turnover = $992000 / $503000 = 1.97 Unchanged

ROI = 9.88% * 1.97 = 19.46% Increase

4) If Average Operating Assets Increase by $123000 and Net Operating Income Increase by $5000 per year.

Bond's Interest not Affect to Net Operating Income.

New Average Operating Assets = $503000 + $123000 = $626000

New Net Operating Income = $84000 + $5000 = $89000

Margin = ($89000 / $992000)*100 = 8.97% Increase

Investment Turnover = $992000 / $626000 = 1.58 Decrease

ROI = 8.97% * 1.58 = 14.17% Decrease

5) If Sales Increase by 25% that Contribution Margin Increase by 25%.

New Sales = $992000 * 125% = $1240000

New Net Operating Income = Increased Contribution - Fixed Cost

= ($396800*125%) - $312800

= $496000 - $312800

= $183200

Margin = ($183200 / $1240000)*100 = 14.77% Increase

Investment Turnover = $1240000 / $503000 = 2.46 Increase

ROI = 14.77% * 2.46 = 36.33%

6) If Scrapped cost of $17000 written off as loss.

New Net Operating Income = $84000 - $17000 = $67000

New Average Operating Assets = $503000 - $17000 = $486000

Margin = ($67000 / $992000)*100 = 6.75% Decrease

Investment Turnover = $992000 / $486000 = 2.04 Increase

ROI = 6.75% * 1.97 = 13.297 % Decrease

7) Effect Only on Average Operating Assets. Average Operating Assets decrease by $175000.

New Average Operating Assets = $503000 - $175000 = $328000

Margin = ($84000 / $992000)*100 = 8.46% Increase

Investment Turnover = $992000 / $328000 = 3.02 Increase

ROI = 8.46% * 3.02 = 25.55% Increase

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