Question

Problem 11-20 (Algo) Return on Investment (ROI) Analysis [LO11-1]

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

	Total		Unit
Sales	$	996,000	$	49.80
Variable expenses		597,600		29.88
Contribution margin		398,400		19.92
Fixed expenses		316,400		15.82
Net operating income		82,000		4.10
Income taxes @ 40%		32,800		1.64
Net income	$	49,200	$	2.46

The company had average operating assets of $496,000 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.

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 $98,000. (The released funds are used to pay off short-term creditors.)

3. The company achieves a cost savings of $10,000 per year by using less costly materials.

4. The company issues bonds and uses the proceeds to purchase machinery and equipment that increases average operating assets by $121,000. Interest on the bonds is $15,000 per year. Sales remain unchanged. The new, more efficient equipment reduces production costs by $4,000 per year.

5. As a result of a more intense effort by sales people, sales are increased by 20%; operating assets remain unchanged.

6. At the beginning of the year, obsolete inventory carried on the books at a cost of $19,000 is scrapped and written off as a loss.

7. At the beginning of the year, the company uses $179,000 of cash (received on accounts receivable) to repurchase and retire some of its common stock.

Answer 1

Question no 1

Question 2

By following the lean production technique the company has been able to reduce the inventory holding by 98,000. This will not result in increase in sales. If the company has working capital loan then this saving will reduce the working Capital interest. Since Interest details are not given its is assumed that as result of this there will be no impact on the margins.

Question 3

Cost saving of Rs 10,000. This will increase the margin

Question 4 This will lower the margins

This after considering the change in cost by 4,000 and increased Interest expenders by 15,000

Question 5 This will increase the sales and margins

Increase of 20% will be more 4,000 extra units. Variable cost of 4,000 additional units are considered (29.88*4000 = 119520).

Other cost will remain un altered.

Question no 6 This will reduce the margin

Write off stock will increase the expenses and this will reduce the margin.

Question no 7

Repurchase of stock will not increase the sales or reduce the margins.