Question

Principal Skinner Company produces gourmet cheeses. Selected results from the most current year were as follows:

                             Sales revenue                               $3,500,000

                             Operating income                           560,000

                             Assets 1/1                                     5,000,000

                             Assets 12/31                                5,800,000

                             Current liabilities 12/31               925,000

                             Long-term Liabilities 12/31      3,050,000

Production manager Marge Simpson is considering investing in the purchase of a new fermenting station that will increase the plant’s production capacity. Based on her research, Marge thinks the station would cost $2,200,000 and would increase sales revenue by $1,750,000 and operating income by $450,000.

1. Calculate Principal Skinner’s current sales margin, asset turnover, and return on investment.
2. Calculate Principal Skinner’s sales margin, asset turnover, and return on investment assuming the company purchases the new fermenting station.
3. Assume Marge Simpson’s annual bonus is based on the company’s return on investment. Will Marge support the purchase of the new fermenting station? Why or why not?

Answer 1

Answer :

Requirement	-	Sales margin	Asset Turnover	ROI
1	Present	16%	0.65	10.4%
2	After purchase	19.24%	0.69	13.28%

Explanation :

(1)(2).

-	Present (1)	New Purchase (2)	Total (1+2)
Sales (A)	$3,500,000	$1,750,000	$5,250,000
Net operating income (B)	$560,000	$450,000	$1,010,000
Net operating assets (C)	$5,400,000	$2,200,000	$7,600,000
Margin (D) = (B / A)	16%	25.7%	19.24%
Turnover (E) = (A / C)	0.65	0.80	0.69
ROI (F) = (D*E)	10.4%	20.56%	13.28%

[(Avg op assets : $5,000,000 + 5,800,000/2) = $5,400,000]

(3).

Margin will support the decision as it increases overall ROI from 10.4% to 13.28%.

Since bonus is based on ROI, it is favorable situation from him.