Question

Local Co. has sales of $10.6 million and cost of sales of $5.7 million. Its? selling, general and administrative expenses are??$520,000 and its research and development is $1.1 million. It has annual depreciation charges of $1.1 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 $320,000?, how would that affect each of its? margins?

e. If Local Co.had interest expense of $750,000?,how would that affect each of its? margins?

Answer 1

Before we start answering the questions, let us prepare how the income statement would look like for the company:

a) Gross Margin

Gross Margin = Gross Profit/Sales = 6.9/10.6 = 65.09%

b) Operating margin

Operating margin = Operating profit/Sales = 4.18/10.6 = 39.43%

c) Net profit margin

Net profit margin = Net Income/Sales = 2.717/10.6 = 25.63%

d) When selling expenses increase, gross margins do not change. Only operating margin and net profit margin change. This is how income statement would now look like:

So now, Operating margin = 3.86/10.6 = 36.42%

Net profit margin = 2.509/10.6 = 23.67%

e) If they had interest expenses of $750,000, only net profit margin would have been affected since interest expense is deducted from the operating profit before calculating tax. The income statement would have looked like:

So, net profit margin would only one to change.

Net profit margin now would be = 2.022/10.6 = 19.07%