Question

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SUBJECT : ACCOUNTING

The contribution format income statement for Smith & Company for its most recent period is given below:

Total

Unit

Sales

$500,000

$50.00

Less variable expenses

300,000

30.00

Contribution margin

200,000

20.00

Less fixed expenses

160,000

Operating income

40,000

Less income taxes at 40%

16,000

Net income

$ 24,000

The company had average operating assets of $250,000 during the period.

Required:

1. Compute the company’s 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 original ROI computed in (1) above.

2. The company achieves cost savings of $10,000 per period by using less costly materials.

3. Using lean production, the company is able to reduce the average level of inventory by $50,000. (The released funds are used to pay off bank loans.)

4. Sales are increased by $50,000; operating assets remain unchanged.

5. The company issues bonds and uses the proceeds to purchase $75,000 in

machinery and equipment at the beginning of the period. Interest on the bonds is $2,000 per period. Sales remain unchanged. The new, more efficient equipment reduces production costs by $4,000 per period.

6. The company invests $50,000 in cash (received on accounts receivable) in a plot of land that is to be held for possible future use as a plant site.

7. Obsolete inventory carried on the books at a cost of $5,000 is scrapped and written off as a loss

Answer 1

From the given information

Sales Margin= Net Income/ Total Sales= $ 24000/$500000 =24/500= 6/125

Capital Turnover = Sales Value/ Invested Capital (operating asset) =$500000/$ 250000 =2

so the ROI= Sales Margin/ Capital Turn Over = (6/125)/2 =3/125 = 2.4 %

hence

1. ROI is 2.4 %

2. If the company use less costly material and save $ 10000,

Total Unit Sales ($)	500000
Variable Exp	290000
Contribution Margin	210000
Fixed Expense	160000
Operating Income	50000
income tax (40%)	20000
Net income($)	30000

Then the new Net income would be $ 30000

Sales Margin =30000/500000=3/50

New ROI= (3/50)/2= 3% ( There in increase in ROI)

3) In this Case The capital Turn over = 500000/200000= 2.5

Av operating asset	200000
Total Unit Sales ($)	500000
Variable Exp	250000
Contribution Margin	250000
Fixed Expense	160000
Operating Income	90000
income tax (40%)	36000
Net income($)	54000
Sales margin	0.108
Capital TO	2.5
ROI	4.32 ( Increase)

4)

Av operating asset	250000
Total Unit Sales ($)	550000
Variable Exp	250000
Contribution Margin	300000
Fixed Expense	160000
Operating Income	140000
income tax (40%)	56000
Net income($)	84000
Sales margin	0.153
Capital TO	2.2
ROI (%)	6.94 ( Increase)

5)

Av operating asset	325000
Total Unit Sales ($)	500000
Variable Exp	300000
Contribution Margin	200000
Fixed Expense	162000
Operating Income	38000
income tax (40%)	15200
Net income($)	22800
Sales margin	0.046
Capital TO	1.54
ROI (%)	2.96 (increase)

6)

Av operating asset	300000
Total Unit Sales ($)	500000
Variable Exp	300000
Contribution Margin	200000
Fixed Expense	160000
Operating Income	40000
income tax (40%)	16000
Net income($)	24000
Sales margin	0.048
Capital TO	1.67
ROI (%)	2.88 ( Increase)

7)

Av operating asset	250000
Total Unit Sales ($)	500000
Variable Exp	300000
Contribution Margin	200000
Fixed Expense	160000
Operating Income	35000
income tax (40%)	14000
Net income($)	21000
Sales margin	0.042
Capital TO	2.00
ROI (%)	2.10 (decrease)

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