Question

Profit Margin, Investment Turnover, and return on investment The condensed income statement for the Consumer Products Division of Fargo Industries Inc. is as follows (assuming no service department charges): Sales $912,000 Cost of goods sold 410,400 Gross profit $501,600 Administrative expenses 228,000 Income from operations $273,600 The manager of the Consumer Products Division is considering ways to increase the return on investment. a. Using the DuPont formula for return on investment, determine the profit margin, investment turnover, and return on investment of the Consumer Products Division, assuming that $1,520,000 of assets have been invested in the Consumer Products Division. Round the investment turnover to one decimal place. Profit margin % Investment turnover Rate of return on investment % b. If expenses could be reduced by $45,600 without decreasing sales, what would be the impact on the profit margin, investment turnover, and return on investment for the Consumer Products Division? Round the investment turnover to one decimal place. Profit margin % Investment turnover Rate of return on investment %

Answer 1

Income Statement

Sales	912,000
Less:- Cost of goods sold	(410,400)
Gross Income	501,600
Less:- Administrative Expenses	(228,000)
Income from Operations	273,600

A. Calculating Return on Investment using DuPont formula:-

Return on Investment= {(Operating Income/Sales)× (Sales/Investment)}×100

={(273,600/912,000)×(912,000/1,520,000)}×100

=(0.3×0.6)×100 = 0.18×100=18%

Calculation of Profit Margin:-

Profit Margin=(Net Income/Sales)×100

= (273,600/912,000)×100=0.3×100=30%

Calculating Investment Turnover Ratio:-

Investment Turnover Ratio=Sales/Investment

=912,000/1,520,000=0.6 times

B. Expenses reduced by $45,600

Income Statement

Sales	912,000
Less:- Cost of goods sold	(410,400)
Gross Income	501,600
Less:- Administrative Expenses ($228,000-$45,600)	182,400
Income from Operations	319,200

Calculating return on Investment, Profit Margin and Investment Turnover Ratio to know the impact of change.

Calculating Return on Investment using Dupont Formula:-

={(Operating Income/Sales)×(Sales/Investment)}×100

={(319,200/912,000)×(912,000/1,520,000)}×100

=(0.35×0.6)×100=21%

Calculating Profit Margin:-

=(Net Income/Sales)×100

=(319,200/912,000)×100=0.35×100=35%

Calculating Investment Turnover Ratio:-

=Sales/Investment

=912,000/1,520,000

=0.6 times

Reduction of expenses effect Return on Investment which is Increasing 18% to 21% and Profit Margin which is increasing 30% to 35%. It has not effect on Investment Turnover Ratio, it's remains same as above.