Effect of Proposals on Divisional Performance A condensed income statement for t

Question

Effect of Proposals on Divisional Performance

A condensed income statement for the Golf Division of Rewind Sports Inc. for the year ended December 31, 2016, is as follows:

Assume that the Golf Division received no charges from service departments. The president of Rewind Sports has indicated that the division's rate of return on a $1,700,000 investment must be increased to at least 19.5% by the end of the next year if operations are to continue. The division manager is considering the following three proposals:

Proposal 1: Transfer equipment with a book value of $340,000 to other divisions at no gain or loss and lease similar equipment. The annual lease payments would exceed the amount of depreciation expense on the old equipment by $61,200. This increase in expense would be included as part of the cost of goods sold. Sales would remain unchanged.

Proposal 2: Purchase new and more efficient machining equipment and thereby reduce the cost of goods sold by $224,400 after considering the effects of depreciation expense on the new equipment. Sales would remain unchanged, and the old equipment, which has no remaining book value, would be scrapped at no gain or loss. The new equipment would increase invested assets by an additional $850,000 for the year.

Proposal 3: Reduce invested assets by discontinuing a product line. This action would eliminate sales of $361,300, cost of goods sold of $241,400, and operating expenses of $106,300. Assets of $860,700 would be transferred to other divisions at no gain or loss.

Required:

1. Using the DuPont formula for rate of return on investment, determine the profit margin, investment turnover, and rate of return on investment for the Golf Division for the past year. Round your answers to one decimal place.

2. Prepare condensed estimated income statements and compute the invested assets for each proposal.

3. Using the DuPont formula for rate of return on investment, determine the profit margin, investment turnover, and rate of return on investment for each proposal. Round your answers to one decimal place.

4. Select whether each of the three proposals would meet the required 19.5% rate of return on investment.

5. If the Golf Division were in an industry where the profit margin could not be increased, how much would the investment turnover have to increase to meet the president's required 19.5% rate of return on investment? Enter your increase in investment turnover answer as a percentage of current investment turnover. If required, round your answer to one decimal place.
%

Explanation / Answer

1 Yr. ended Dec.31,2016 Golf Division Profit margin(Net Income/Sales) 265200/2040000= 13% Investment turnover(Sales/Investment) 2040000/1700000= 1.2 ROI(13%*1.2) same as    265200/1700000= 15.6% 2. Condensed estimated income statements to compute the invested assets for each proposal. Rewind Sports Inc.-Golf Division Estimated Income Statements For the Year Ended December 31, 2016 Proposal 1 Proposal 2 Proposal 3 Sales $2,040,000 $2,040,000 $1,678,700 Cost of goods sold 1,475,000 1,189,400 1,172,400 Gross profit $565,000 $850,600 $506,300 Operating expenses 361,000 361,000 254,700 Income from operations $204,000 $489,600 $251,600 Invested assets $1,360,000 $2,550,000 $839,300 3 Profit Margin Investment Turnover ROI= Profit Margin*Inv.T.O. Proposal 1 204000/2040000= 10.00% 2040000/1360000= 1.5 15.00% Proposal 2 489600/2040000= 24.00% 2040000/2550000= 0.8 19.20% Proposal 3 251600/1678700= 14.99% 1678700/839300= 2.000119 29.98% 4 Proposal 1 No Proposal 2 No Proposal 3 Yes 5. Reqd. ROI 19.50% Profit margin 13% So, Investment turnover should be 19.50%/13%= 1.5 In the base case it is 1.2 Ie. Increase of 1.5-1.2= 0.3 Ie. 0.3/1.2= 25% Over the current level

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