.Question (4) A business\'s sales have grown by 15% in each of the past two year

Question

.Question (4) A business's sales have grown by 15% in each of the past two years. The ratio of its sales to gross fixed assets has declined during this time. Which one of the following conclusions is the correct one to draw from this trend? The business is adding to its fixed assets more slowly than its sales are growing. The business is adding to its fixed assets faster than its sales are growing The business is no longer using accelerated depreciation. The business has not purchased any additional fixed assets beyond replacing existing assets

Explanation / Answer

In the given case Sales are increasing at 15%, thus sales to fixed assets Ratio should also increase. But here as given sales to fixed assets ratio has declined.

Sales to Fixed assets Ratio

= SALES / FIXED ASSETS

So it clear that if sales to Fixed assets ratio has declined even after increase in sale then it means fixed assets has increased by amount more than increase in sales.

We can analyze options with an example below

Assume sales for first year is 1000 $

And Fixed Assets are 500 $

So for first year Sales to Fixed Assets Ratio

= Sales / Fixed Assets

= 1000 / 500

= 2 : 1

Sales for next Year

= Sales x 1.15

= 1000 x 1.15

= 1150 $

It means sales has been increased by 150 $

Analysis -

option A

If business is adding to fixed assets slowly then Sales are growing

If Increase in Fixed assets ( say 10 % )

Ratio

= 1150 $ / (500 x 1.10)

= 1150 $ / 550 $

= 2.09 : 1

As in the given case ratio has declined, but here it is increasing so this option is not correct.

Option 2

Business is adding to fixed assets faster than sales are growing

Increase in Fixed assets ( Say 20 %)

Ratio

= 1150 $ / (500 x 1.20 )

= 1150 $ / 600 $

= 1.91 : 1

As in the given case the sales to fixed assets ratio has declined the same is happening because company is adding to its fixed assets faster than sales are growing.

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