Question

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

	Total		Unit
Sales	$	1,008,000	$	50.40
Variable expenses		604,800		30.24
Contribution margin		403,200		20.16
Fixed expenses		327,200		16.36
Net operating income		76,000		3.80
Income taxes @ 40%		30,400		1.52
Net income	$	45,600	$	2.28

The company had average operating assets of $492,000 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 $103,000. (The released funds are used to pay off short-term creditors.)

3. The company achieves a cost savings of $8,000 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 $127,000. Interest on the bonds is $14,000 per year. Sales remain unchanged. The new, more efficient equipment reduces production costs by $7,000 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 $19,000 is scrapped and written off as a loss.

7. At the beginning of the year, the company uses $183,000 of cash (received on accounts receivable) to repurchase and retire some of its common stock.

Answer 1

Sales Varaible Expenses Contribution Margin Fixed Expenses Net operating income Income Tax @ 40% Net income Total Unit 1008000 604800 403200 327200 76000 30400 45600 50.40 30.24 20.16 16.36 3.80 1.52 2.28 Average operating Assets 492000 Companie's ROI sales Net Operating income (NOI) Operating Assets 1008000 76000 492000 Margin= (NOI/ Sales) Turnover =( Sales / Operating Assets) ROI =( NOI/ Operating Assets) 7.54% 2.05 15.45%

IF Firm Reduce the Average level of inventory BY 103000 Average Assets = (492000-103000) 389000 sales 1008000 Net Operating income (NOI) 76000 Operating Assets 389000 Margin= (NOI/ Sales) Turnover =( Sales / Operating Assets) ROI =( NOI/ Operating Assets) Effect 7.54% Un Changed 2.59 Increase 19.54% Increase Cost Saving by 8000 sales Net Operating income (NOI) (76000+8000) Operating Assets 1008000 84000 492000 Margin= (NOI/ Sales) Turnover =( Sales / Operating Assets) ROI =( NOI/ Operating Assets) Effect 8.33% Increase 2.05 Unchange 17.07% Increase

4) IF the Firm issue a bond $127,000, Prodcution Cost will Reduce by 7000 Bond issue 127000 Cost saving 7000 sales Net Operating income (NOI) Operating Assets 1008000 83000 619000 Effect 8.23% Increase 1.63 Decrease 13.41% Decrease 5) Margin= (NOI/ Sales) Turnover =( Sales / Operating Assets) ROI =( NOI/ Operating Assets) Sales Increase by 15% Sales increase in contibtion Margin Fixed cost Netoperating income Operating Assets 15% 1159200) 463680 327200 136480 492000 Effect 11.77% Increase 2.36 Increase 27.74% Increase Margin= (NOI/ Sales) Turnover =( Sales / Operating Assets) ROI =( NOI/ Operating Assets)

Obsolete inventory Carried on the at a cost of $19000 6) Obsolete inventory 19000 sales Net Operating income (NOI) Operating Assets 1008000 57000 473000 Margin= (NOI/ Sales) Turnover =( Sales / Operating Assets) ROI =( NOI/ Operating Assets) Effect 5.65% Decrease 2.13 Increase 12.05% Decreased Use Cash for Retire Common Stock 7) Retire Common Stock 1,83,000 sales Net Operating income (NOI) Operating Assets 1008000 76000 309000 Margin= (NOI/ Sales) Turnover =( Sales / Operating Assets) ROI =( NOI/ Operating Assets) Effect 7.54% Unchanged 3.26 Increase 24.60% Increase