Question

The contribution format income statement for Huerra Company for last year is given below:

	Total		Unit
Sales	$	1,000,000	$	50.00
Variable expenses		600,000		30.00
Contribution margin		400,000		20.00
Fixed expenses		324,000		16.20
Net operating income		76,000		3.80
Income taxes @ 40%		30,400		1.52
Net income	$	45,600	$	2.28

The company had average operating assets of $505,000 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. (Round your intermediate calculations and final answer to 2 decimal places.)

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 ROI figure. Consider each question separately, starting in each case from the data used to compute the original ROI in (1) above.

2. Using Lean Production, the company is able to reduce the average level of inventory by $97,000. (The released funds are used to pay off short-term creditors.) (Round your answers to 2 decimal places.)

3. The company achieves a cost savings of $7,000 per year by using less costly materials. (Round your answers to 2 decimal places.)

4. The company issues bonds and uses the proceeds to purchase $127,000 in machinery and equipment at the beginning of the period. Interest on the bonds is $12,000 per year. Sales remain unchanged. The new, more efficient equipment reduces production costs by $5,000 per year. (Round your answers to 2 decimal places.)

5. Sales are increased by 20%; operating assets remain unchanged. (Round your answers to 2 decimal places.)

6. Obsolete inventory carried on the books at a cost of $20,000 is scrapped and written off as a loss. (Round your answers to 2 decimal places.)

7. The company uses $183,000 of cash (received on accounts receivable) to repurchase and retire some of its common stock. (Round your answers to 2 decimal places.)

Answer 1

the formula used

Margin = net operating income / sales

turnover =sales / average operating assets

return on investment = margin * turnover

(1) Present status

ROI
Net operating Income	$76,000
Sales	$1,000,000
Average operating asssets	$505,000
margin	7.6%
Turnover	1.98
ROI	15.05%

(2) change in inventory by $97,000

ROI
Net operating Income	$76,000
Sales	$1,000,000
Average operating asssets	$408,000
margin	7.6%
Turnover	2.45
ROI	18.62%

(3) cost savings of $7000 per year by using less costly material

ROI
Net operating Income	$83,000
Sales	$1,000,000
Average operating asssets	$505,000
margin	8.3%
Turnover	1.98
ROI	16.43%

(4) issue of bonds for machinery and equipment

ROI
Net operating Income	$81,000
Sales	$1,000,000
Average operating asssets	$632,000
margin	8.1%
Turnover	1.58
ROI	12.80%

(5) Increase in sale by 20%

ROI
Net operating Income	$156,000
Sales	$1,200,000
Average operating asssets	$505,000
margin	13%
Turnover	2.38
ROI	30.94%

(6) Obsolete inventory scrapped at $20,000

ROI
Net operating Income	$56,000
Sales	$1,000,000
Average operating asssets	$485,000
margin	5.6%
Turnover	2.06
ROI	11.54%

(7) cash received from accounts receivable used to retire common stock for $183,000

ROI
Net operating Income	$76,000
Sales	$1,000,000
Average operating asssets	$322,000
margin	7.6%
Turnover	3.11
ROI	23.64%