Question

Problem One Yummy's is a restaurant chain operating in select cities in the Carolinas. Select financial data is presented below to provide you with the necessary content for perfromance evaluation purposes. Charlotte Greenville Columbia Restaurant Restaurant Restaurant Total Sales revenue 3,185,000 1,400,000 1,200,000 5,785,000 Variable costs 995,000 375,000 310,000 1,680,000 Fixed costs 1,680,000 725,000 650,000 3,055,000 Operating income 510,000 300,000 240,000 1,050,000 Interest costs on long-term debt at 10% 450,000 Income before income taxes 600,000 Income taxes at 30% 180,000 Net income 420,000 Net book values at the end of 2016: Current assets 660,000 500,000 400,000 1,560,000 Long-term assets 2,340,000 1,500,000 600,000 4,440,000 Total assets 3,000,000 2,000,000 1,000,000 6,000,000 Current liabilities 300,000 150,000 50,000 500,000 Long-term debt 4,500,000 Stockholders' equity 1,000,000 Total liabilities and stockholders' equity 6,000,000 Requirement: You should look at each of these three types of adjustments (reduce assets, increase sales and decrease fixed costs) and discuss the preferred approach from a strategic perspective. Your explanation should extend beyond the impact the adjustment has on ROI. For example, do you see any disadvantages from each type of adjustment?

Answer 1

Calculations on the basis of Given Data :-

1) Return on Investment (ROI) :

Return On Investment =                 Return                                x              100

Investment

Where;

Return = Operating Income (ie. Income earned from Invested Long Term Funds)= $ 1,050,000

Investment = Long Term Funds Invested in the Business (which includes both Debt and Equity but doesnot includes Current Liability) = $ 5,500,000

Therefore , ROI = $1,050,000 / $5,500,000 x 100 = 19.10%

2) Profit Volume Ratio

Particular	Charlotte Restaurant	Greenville Restaurant	Columbia Restaurant	Total
Sales revenue (A)	31,85,000	14,00,000	12,00,000	57,85,000
Variable costs (B)	9,95,000	3,75,000	3,10,000	16,80,000
Contribution (C = A-B)	21,90,000	10,25,000	8,90,000	41,05,000
Profit Volum Ratio (D = C / A x 100)	68.76%	73.21%	74.17%	70.96%

3) Asset Turnover Ratio

Particular	Charlotte Restaurant	Greenville Restaurant	Columbia Restaurant	Total
Total assets (A)	30,00,000	20,00,000	10,00,000	60,00,000
Sales (B)	31,85,000	14,00,000	12,00,000	57,85,000
Asset Turnover Ratio (Times) (C = B / A )	1.06	0.70	1.20	0.96

Adjustment - 1) Increase sales by 10% (Assumed in the absence of specific Information and consistently applied on other adjustments)

Particular	Charlotte Restaurant	Greenville Restaurant	Columbia Restaurant	Total
Old Sales Revenue	3185000	1400000	1200000	5785000
New Sales (Increased by 10%)	3503500	1540000	1320000	6363500
Profit Volum Ratio	68.76%	73.21%	74.17%	70.96%
Contribution	2409000	1127500	979000	4515500
Fixed costs	1680000	725000	650000	3055000
Operating income	729000	402500	329000	1460500
Interest costs on long-term debt at 10%				450000
Income before income taxes				1010500
Income taxes at 30%				303150
Net income				707350

Revised Return On Investment = Return / Investment * 100

Where;

Return = Operating Income (ie. Income earned from Invested Long Term Funds) = $ 1,460,500

Investment = Long Term Funds Invested in the Business (which includes both Debt and Equity but doesnot includes Current Liability) = $ 5,500,000

Therefore , ROI = $ 1,460,500 / $ 5,500,000 x 100 = 26.55%

Analysis : If we increase the sales by 10%, the consequent increase in ROI is 7.45 % . It also lead to increase Net Income by $ 287350

Adjustment - 2) Decrease Fixed Cost by 10% (Assumed in the absence of specific Information and consistently applied on other adjustments)

Particular	Charlotte Restaurant	Greenville Restaurant	Columbia Restaurant	Total
Sales Revenue	3185000	1400000	1200000	5785000
Profit Volum Ratio	68.76%	73.21%	74.17%	70.96%
Contribution	2190000	1025000	890000	4105000
Fixed costs	1512000	652500	585000	2749500
Operating income	678000	372500	305000	1355500
Interest costs on long-term debt at 10%				450000
Income before income taxes				905500
Income taxes at 30%				271650
Net income				633850

Revised Return On Investment = Return / Investment * 100

Where;

Return = Operating Income (ie. Income earned from Invested Long Term Funds) = $ 1,355,500

Investment = Long Term Funds Invested in the Business (which includes both Debt and Equity but doesnot includes Current Liability) = $ 5,500,000

Therefore , ROI = $ 1,355,500 / $ 5,500,000 x 100 = 24.64%

Analysis : If we decrease the fixed cost by 10%, the consequent increase in ROI is 5.54 % . It also lead to increase Net Income by $ 213,850.

Adjustment - 3) Reduce assets by 10 % (Assumed in the absence of specific Information)

Particular	Charlotte Restaurant	Greenville Restaurant	Columbia Restaurant	Total
Total assets	2700000	1800000	900000	5400000
Asset Turnover Ratio (Times)	1.06	0.70	1.20	0.96
New Sales	2866500	1260000	1080000	5206500
Profit Volum Ratio	68.76%	73.21%	74.17%	70.96%
Contribution	1971000	922500	801000	3694500
Fixed costs	1680000	725000	650000	3055000
Operating income	291000	197500	151000	639500
Interest costs on long-term debt at 10%				450000
Income before income taxes				189500
Income taxes at 30%				56850
Net income				132650

Revised Return On Investment = Return / Investment * 100

Where;

Return = Operating Income (ie. Income earned from Invested Long Term Funds) = $ 639,500

Investment = Long Term Funds Invested in the Business ( Total Assets - Current Liabilities ) = 5,400,000 - 500,000 = $4,900,000

Therefore , ROI = $ 639,500 / $ 4,900,000 x 100 = 13.05%

Analysis : As a result of reducing assets by 10 % , the ROI reduced by 6.05%. It is so because reducing of assets have a negative impact on revenue which further results in decreased operating Income. Although reduction in assets also decreases the amount invested in business yet the decrease in operating income is proportionately higher than the decrease in Investment hence resulted in negative impact on ROI. It also results in decrease in net Income by $ 287,350

Net Result of all adjustments and Strategic Decision Making :

Particular	ROI	Imapct on ROI	Net Income	Impact on Net Income
Base Data	19.10%	0	420000	0
Increase Sales	26.55%	7.45%	707350	287350
Decrease Fixed Cost	24.64%	5.54%	633850	213850
Decrease Assets	13.05%	-6.05%	132650	-287350

Strategic Decision Making :- It is clearly evident from the above data that both ROI and Net Income is highest if Sales are increased. It is because by increasing revenue the organisation is able to optimally utilize the resources available with the organisation resulting in higher net income. Therefore the best approach from management prospective to achieve the goals of the organisation should be to maximize the sales.

It should also be observed that reducing assets has a negative impact on both ROI and Net Income, therefore Management should avoid reducing assets in all circumstances.