Question

Profit Margin, Investment Turnover, and return on investment

The condensed income statement for the Consumer Products Division of Fargo Industries Inc. is as follows (assuming no service department charges):

Sales | $1,144,000 |

Cost of goods sold | 514,800 |

Gross profit | $629,200 |

Administrative expenses | 400,400 |

Income from operations | $228,800 |

The manager of the Consumer Products Division is considering ways to increase the return on investment.

**a.** Using the DuPont formula for return on
investment, determine the profit margin, investment turnover, and
return on investment of the Consumer Products Division, assuming
that $2,860,000 of assets have been invested in the Consumer
Products Division. Round the investment turnover to one decimal
place.

Profit margin | % |

Investment turnover | |

Rate of return on investment | % |

**b.** If expenses could be reduced by $57,200
without decreasing sales, what would be the impact on the profit
margin, investment turnover, and return on investment for the
Consumer Products Division? Round the investment turnover to one
decimal place.

Profit margin | % |

Investment turnover | |

Rate of return on investment | % |

Answer #1

(a)

Profit margin = Income from operations/Sales

= 228,800/1,144,000

= 20%

Investment turnover = Sales/Total assets

= 1,144,000/2,860,000

= 0.4

Rate of return on investment = Profit margin x Investment turnover

= 20% x 0.4

= 8%

(b)

Reduction in expenses = $57,200

Reduction in expenses of $57,200 will increase operating income by $57,200

Hence, Income from operation will become = 228,800 + 57,200

= $286,000

Profit margin = Income from operations/Sales

= 286,000/1,144,000

= 25%

Investment turnover = Sales/Total assets

= 1,144,000/2,860,000

= 0.4

Rate of return on investment = Income from operations/Total assets

= 25% x 0.4

= 10%

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