The contribution format income statement for Huerra Company for last year is giv

Question

The contribution format income statement for Huerra Company for last year is given below: Total Unit Sales Variable expenses Contribution margin Fixed expenses Net operating income Income taxes @ 40% Net income 1,000,000 $ 50.00 30.00 20.00 15.80 4.20 1.68 $50,400 2.52 600,000 400,000 316,000 84,000 33,600 The company had average operating assets of $501,000 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 ROl figure. Consider each question separately, starting in each case from the data used to compute the original ROl in (1) above 2. Using Lean Production, the company is able to reduce the average level of inventory by $100,000. (The released funds are used to pay off short-term creditors.) 3. The company achieves a cost savings of $5,000 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 $127,000. Interest on the bonds is $18,000 per year. Sales remain unchanged. The new, more efficient equipment reduces production costs by $7,000 per year. As a result of a more intense effort by sales people, sales are increased by 20%; operating assets remain unchanged

Explanation / Answer

Concept -

(1) Margin = (Net operating Income/Sales)*100 = ($84000/1000000)*100 = 8.4%

(2) Turnover = Sales/Average Operating assets = $1000000/$501000 = 2.00

(3) RoI = (Net operating Income/Average operating asset)*100

= ($84000/$501000)*100 = 16.77%

Part 1 - Calculation of ROI (Return on Investment)

RoI = (Net Operating income/Average Operating Assets)*100

Part 2 - Average Level of Inventory reduced by $100000

Effect - Only Average Operating assets reduced = ($501000 - $100000) = $401000 hence only Roi and turnover will change. Margin will not change

Part 3 - Cost savings achieved by $5000 per year

Only Net Operating income increased by $5000. New net operating income will be ($84000 + $5000) = $89000

Hence Margin ratio and Roi will change. Turnover ratio remain unchanged

Part 4 - Net Operating income will increased by $7000.sales will not changed and Operating assets increased by $127000

New Net operating Income ($84000 + $7000) = $91000

New Net operating assets = ($501000 + $127000) = $628000

This will effect Turnover, Margin and Roi

Part 5 - Sales are increased by 20%. Change in sales will effect Margin, Turnover and Roi ratio.

Contribution ratio = $400000/$1000000*100 = 40%

New Income Statement

Effects

Part 6 - Inventory scrapped as loss by $20000. Such Treatment will results into decrease in Average operating assets and Net operating Income by $20000

Net Operating Income = ($84000 - $20000) = $64000

Average Operating Assets = ($501000 - $20000) = $481000

Hence Margin, Turnover, ROI will be changed

Part 7 - Cash Used for retiring common stock

Operating assets would be lower by $183000. Average operating assets will be ($501000 - $183000) = $318000

Hence Margin ration will be uneffected but Turnover and Roi will be changed

Particulard Net Operating Income $84000 Average Operating Assets $501000 Return on Investment ($84000/501000)*100 16.77%

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