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:

Sales: Year 1 $12,000,000, Year 2 $ 9,500,000, Year 3 $9,000,000

Operating income: Year 1 $1,200,000, Year 2 $1,445,000, Year 3 $945,000

Average assets: Year 1 15,000,000, Year 2  15,000,000, Year 3 17,000,000

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.

Required 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.

Required 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.

Required 4. Conceptual Connection: Assume that all expectations for Year 4 were realized. Compute the expected ROI, margin, and turnover.

Answer 1

1)
Year	1	2	3
Sales	$ 12,000,000.00	$   9,500,000.00	$   9,000,000.00
Operating Income	$   1,200,000.00	$   1,445,000.00	$      945,000.00
Average Assets	$ 15,000,000.00	$ 15,000,000.00	$ 17,000,000.00
Year	1	2	3
ROI = Margin x Turnover	8.00%	9.63%	5.56%
Margin  = Operating Income/Sales	10.00%	15.21%	10.50%
Turnover  = Sales/ Average Operating Assets	0.80	0.63	0.53
2)
Sales	$ 12,000,000.00
Operating Income	$   1,200,000.00
Average Assets	$ 15,000,000.00
ROI = Margin x Turnover	8.00%
Margin  = Operating Income/Sales	10.00%
Turnover  = Sales/ Average Operating Assets	0.80
The ROI increased because expenses decreased and assets turned over at a higher rate (sales increased).
3)
Sales	$   9,000,000.00
Operating Income	$      945,000.00
Average Assets	$ 13,600,000.00
ROI = Margin x Turnover	6.95%
Margin  = Operating Income/Sales	10.50%
Turnover  = Sales/ Average Operating Assets	0.66
The ROI increased because assets decreased
4)
Sales	$ 12,000,000.00
Operating Income	$   1,200,000.00
Average Assets	$ 12,000,000.00
ROI = Margin x Turnover	10.00%
Margin  = Operating Income/Sales	10.00%
Turnover  = Sales/ Average Operating Assets	1.00
The ROI increased because expenses decreased and assets turned over at a higher rate (sales increased and the amount of assets decreased)