Question

Local Co. has sales of

$ 10.5

million and cost of sales of

$ 6.4

million. Its​ selling, general and administrative expenses are  

$ 550 comma 000

and its research and development is

$ 1.2

million. It has annual depreciation charges of

$ 1.2

million and a tax rate of

35 %

.

a. What is​ Local's gross​ margin?

b. What is​ Local's operating​ margin?

c. What is​ Local's net profit​ margin?

d. If Local Co. had an increase in selling expenses of

$ 330 comma 000

​,

how would that affect each of its​ margins?

e. If Local Co.had interest expense of

$ 760 comma 000

​,

how would that affect each of its​ margins?

Answer 1

The following Income statement is the basis for answering various given questions

Sales		10,500,000
(-) Cost of sales		6,400,000
Gross margin		4,100,000
Operating expenses
Selling, general and admin	550,000
Research and development	1,200,000
Depreciation	1,200,000
Total Operating expenses		2,950,000
Operating Margin		1,150,000
(-) Tax expenses		402500
Net Profit		747,500

Answers to Question - (a), (b) and ( c )

(a) Gross Profit Margin	4,100,000
(b) Operating Profit Margin	1,150,000
(c) Net Profit Margin	747,500

Note : above Income statement explains how these values are obtained. Research expenses should be treated as part of operating expenses.

Question - d

If selling expenses increase by 330,000, there is no impact of Gross margin. But Operating margin and net profit margin shall reduce by 330,000 each.

(a) Gross Profit Margin	4,100,000	No effect
(b) Operating Profit Margin	820,000	Decrease by 330,000
(c) Net Profit Margin	417,500	Decrease by 330,000

Question - e

If the company had Interest expenses of 760,000. It may noted that for categorization of expenses items, interest is a non - operating exenses. Hence there is not effect on gross margin and also no effect on operating margin. But net profit margin shall decrease after tax interest expenses amount. That is 760,000 * ( 1 - 0.35) = 494,000

(a) Gross Profit Margin	4,100,000	No effect
(b) Operating Profit Margin	1,150,000	No effect
(c) Net Profit Margin	253,500	Decrease by 494000