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	$10,000,000	$ 9,500,000	$ 9,000,000
Operating income	1,200,000	1,495,000	945,000
Average assets	15,000,000	15,000,000	16,500,000

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

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

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?

a. The ROI increased because expenses decreased and assets turned over at a higher rate.

b. The ROI increased because expenses increased and assets turned over at a higher rate.

c. The ROI increased because expenses decreased and assets turned over at a lower rate.

d. The ROI increased because expenses increased and assets turned over at a lower rate.

Answer 1

	Year 1	Year 2	Year 3
Sales	$10,000,000	$9,500,000	$9,000,000
Operating income	1,200,000	1,495,000	945,000
Average assets	15,000,000	15,000,000	16,500,000
	Year 1	Year 2	Year 3
ROI = Operating Income/Average Assets	8.00%	9.97%	5.73%
Margin = Operating Income/Sales	12.00%	15.74%	10.50%
Turnover = Sales/Average Assets	0.67	0.63	0.55
Year 4
ROI = 1,200,000/16,500,000	7.27%
Margin = 1,200,000/10,000,000	12.00%
Turnover = 10,000,000/16,500,000	0.61
3
Year 4
ROI = 945000/13,200,000	7.16%
Margin = 1,200,000/9,000,000	10.50%
Turnover = 9,000,000/13,200,000	0.68
4
ROI	9.09%
Margin	12.00%
Turnover	0.76
a. The ROI increased because expenses decreased and assets turned over at a higher rate.