Question

Return on Investment, Margin, Turnover Ready Electronics is facing stiff competition from imported goods. Its operating income margin has been declining steadily for the past several years. The company has been forced to lower prices so that it can maintain its market share. The operating results for the past 3 years are as follows: Year 1 Year 2 Year 3 Sales $14,000,000 $ 9,500,000 $ 9,000,000 Operating income 1,200,000 1,295,000 945,000 Average assets 15,000,000 15,000,000 17,750,000 For the coming year, Ready's president plans to install a JIT purchasing and manufacturing system. She estimates that inventories will be reduced by 70% during the first year of operations, producing a 20% reduction in the average operating assets of the company, which would remain unchanged without the JIT system. She also estimates that sales and operating income will be restored to Year 1 levels because of simultaneous reductions in operating expenses and selling prices. Lower selling prices will allow Ready to expand its market share. (Note: Round all numbers to two decimal places.) Required: 1. Compute the ROI, margin, and turnover for Years 1, 2, and 3. Year 1 Year 2 Year 3 ROI % % % Margin % % % Turnover 2. Conceptual Connection: Suppose that in Year 4 the sales and operating income were achieved as expected, but inventories remained at the same level as in Year 3. Compute the expected ROI, margin, and turnover. ROI % Margin % Turnover Why did the ROI increase over the Year 3 level? 3. Conceptual Connection: Suppose that the sales and net operating income for Year 4 remained the same as in Year 3 but inventory reductions were achieved as projected. Compute the ROI, margin, and turnover. ROI % Margin % Turnover Why did the ROI exceed the Year 3 level? 4. Conceptual Connection: Assume that all expectations for Year 4 were realized. Compute the expected ROI, margin, and turnover. ROI % Margin % Turnover Why did the ROI increase over the Year 3 level?

Answer 1

	Return on investment (ROI)=Operating income/Average operating assets
	Margin=Operating income/Sales
	Turnover=Sales/Average operating assets
1						Year 1	Year 2	Year 3
	Sales				a	14000000	9500000	9000000
	Operating income				b	1200000	1295000	945000
	Average assets				c	15000000	15000000	17750000
	ROI				b/c	8.00%	8.63%	5.32%
	Margin				b/a	8.57%	13.63%	10.50%
	Turnover				a/c	0.93	0.63	0.51
2						Year 4
	Sales				a	14000000
	Operating income				b	1200000
	Average assets				c	17750000
	ROI				b/c	6.76%
	Margin				b/a	8.57%
	Turnover				a/c	0.79
	ROI increased because Operating income in year 4 is more than year 3
3	Average assets=17750000*(100%-20%)=17750000*80%=$ 14200000
						Year 4
	Sales				a	9000000
	Operating income				b	945000
	Average assets				c	14200000
	ROI				b/c	6.65%
	Margin				b/a	10.50%
	Turnover				a/c	0.63
	ROI increased because average assets decreased in year 4
4						Year 4
	Sales				a	14000000
	Operating income				b	1200000
	Average assets				c	14200000
	ROI				b/c	8.45%
	Margin				b/a	8.57%
	Turnover				a/c	0.99
	ROI increased because sales increased and average assets decreased in year 4