Question

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

	Total		Unit
Sales	$	1,002,000	$	50.10
Variable expenses		601,200		30.06
Contribution margin		400,800		20.04
Fixed expenses		318,800		15.94
Net operating income		82,000		4.10
Income taxes @ 40%		32,800		1.64
Net income	$	49,200	$	2.46

The company had average operating assets of $509,000 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 $96,000. (The released funds are used to pay off short-term creditors.)

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 $130,000. Interest on the bonds is $16,000 per year. Sales remain unchanged. The new, more efficient equipment reduces production costs by $4,000 per year.

5. As a result of a more intense effort by sales people, 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 $18,000 is scrapped and written off as a loss.

7. At the beginning of the year, the company uses $180,000 of cash (received on accounts receivable) to repurchase and retire some of its common stock.

Answer 1

1.

20% increase in Sales

Particulars	20,000 Unit	Per Unit	24,000 Units
Sales	$1,002,000	50.10	$1,202,400
Variable expenses	$601,200	30.06	$721,440
Contribution margin	$400,800	20.04	$480,960
Fixed expenses	$318,800	15.94	$382,560
Net operating income	$82,000	4.10	$98,400
Income taxes @ 40%	$32,800	1.64	$39,360
Net income	$49,200	2.46	$59,040
Operating Assets	$509,000
Margin = (Net operating Income/Sales)*100	4.91%
(49200/1002000)*100
Turnover = Sales/Average Operating assets	1.97
1002000/509000

1.

Margin	4.91%
Turnover	1.97
ROI	9.67%

2.

Turnover = Sales/Average Operating assets	2.43
1002000/(509000-96000)
Margin	4.91%
Turnover	2.43
ROI	11.93%

3.

Margin = (Net operating Income/Sales)*100	6.31%
((49200+14000)/1002000)
Turnover	1.97
ROI	12.43%