Question

Principal Skinner Company produces gourmet cheeses. Selected results from the most current year were as follows:

Sales Revenue: $3,500,000

Operating Income: $560,000

Assets 1/1: $5,000,000

Assets 12/31: $5,800,000

Current Liabilities 12/31: $925,000

Long-term Liabilities 12/31: $3,050,000

Production Manager Marge Simpson is considering investing in the purchase of a new fermenting station that will increase the plant’s production capacity. Based on her research, Marge thinks the station would cost $2,200,000 and would increase sales revenue by $1,750,000 and operating income by $450,000.


Required:
1. Calculate Principle Skinner’s current sales margin, asset turnover, and return on investment.

2. Calculate Principle Skinner’s sales margin, asset turnover, and return on investment assuming the company purchases the new fermentation station.

3. Assume Marge’s annual bonus is based on the company’s return on investment. Would Marge support the purchase of the new fermenting station? Why or why not?

Answer 1

1)

sales margin = operating income / sales revenue

sales margin = 560000 / 3500000 = 16%

asset turnover ratio = sales revenue / average assets

where

average assets = (opening assets + closing assets) / 2

average assets = (5000000 + 5800000)/2 = 5400000

asset turnover ratio = 3500000/5400000 = 0.648

return on investment = operating income / capital employed

where

capital employed = assets - current liabilities

capital employed = 5800000 - 925000 = 4875000

return on investment = 560000/4875000 = 11.49%

2)

new sales revenue = 3500000 + 1750000 = 5250000

new assets on 31/12 = 5800000 + 2200000 = 8000000

new operating income = 560000 + 450000 = 1010000

sales margin = operating income / sales revenue

sales margin = 1010000 / 5250000 = 19.24%

asset turnover ratio = sales revenue / average assets

where

average assets = (opening assets + closing assets) / 2

average assets = (5000000 + 8000000)/2 = 6500000

asset turnover ratio = 5250000/6500000 = 0.808

return on investment = operating income / capital employed

where

capital employed = assets - current liabilities

capital employed = 8000000 - 925000 = 7075000

return on investment = 1010000/7075000 = 14.28%

3)

since bonus is linked to return on invetement marge wants a higher roi

since the Return on investment increases to 14.28% from 11.49% , after station is purchased

she will support the purchase of station

Thanks, if you have any doubts please leave a comment and let me know