Question
In: Accounting
The Blue division of the Leaf Company reported the following data for the current year: Sales...
The Blue division of the Leaf Company reported the following data for the current year:
| Sales | $2,600,000 |
| Variable Costs | $2,100,000 |
| Controllable Fixed Costs | $450,000 |
| Average Operating Assets | $5,050,000 |
Senior Management is unhappy with the investment centre’s return on investment. It asks the manager of the Blue division to submit plans to improve the ROI in the next year. The manager believes it is reasonable to consider each of the following independent courses of action
1. Increase sales by $270,000 with no change in the contribution margin percentage
2. Reduce variable costs by $120,000 3. Reduce average operating assets by 4.5%
3. Reduce average operating assets by 4.5%
Required :
a. Calculate the return on investment for the current year.
b. Using the ROI formula, calculate the ROI under each of the proposed courses of action (Round to one decimal)
Solutions
Expert Solution
a. Calculate the return on investment for the current year.
Net income= Sales-Variable costs-Controllable Fixed Costs
= $2600000-2100000-450000= $50000
ROI= Net income/Average operating assets
= $50000*100/5050000= 0.99% or 1%
b. Using the ROI formula, calculate the ROI under each of the proposed courses of action (Round to one decimal)
1. Increase sales by $270,000 with no change in the contribution margin percentage
| Sales (2600000+270000) | $2870000 |
| Less: Variable costs (2100000*2870000/2600000) | 2318077 |
| Contribution margin | 551923 |
| Less: Fixed costs | 450000 |
| Net income | $101923 |
ROI= Net income/Average operating assets
= $101923*100/5050000= 2.0%
2. Reduce variable costs by $120000
| Sales | $2600000 |
| Less: Variable costs (2100000-120000) | 1980000 |
| Contribution margin | 620000 |
| Less: Fixed costs | 450000 |
| Net income | $170000 |
ROI= Net income/Average operating assets
= $170000*100/5050000= 3.4%
3. Reduce average operating assets by 4.5%
New average operating assets= $5050000*95.5%= $4822750
ROI= Net income/Average operating assets
= $50000*100/4822750= 1.04%
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