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 three years are as follows:

     Year 1                       Year 2                         Year 3

Sales                          $10,000,000              $ 9,500,000               $ 9,000,000

Operating income        1,200,000                 1,045,000                     945,000

Average assets         15,000,000              15,000,000               15,000,000

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 percent during the first year of operations, producing a 20 percent 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.

Required:

1. Compute the ROI, margin, and turnover for years 1, 2, and 3.

2. 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. Explain why the ROI increased over the year 3 level.

3. 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. Explain why the ROI exceeded the year 3 level.

4. Assume that all expectations for year 4 were realized. Compute the expected ROI, margin, and turnover. Explain why the ROI increased over the year 3 level.

Answer 1

	Year 1	Year 2	Year 3
Sales	10,000,000	9,500,000	9,000,000
Operating Income	1,200,000	1,045,000	945,000
Average Assets	15,000,000	15,000,000	15,000,000
1.ROI = Operating Income/Average Assets	8.00%	6.97%	6.30%
Margin = Operating Income/Sales	12.00%	11.00%	10.50%
Turnover = Sales/Average Assets	0.67	0.63	0.60
2.
	Year 4
Sales	10,000,000
Operating Income	1,200,000
Average Assets	15,000,000
1.ROI = Operating Income/Average Assets	8.00%
Margin = Operating Income/Sales	12.00%
Turnover = Sales/Average Assets	0.67
ROI increased as operating income increased without any change in average assets
3.
	Year 4
Sales	9,000,000
Operating Income	945,000
Average Assets	12,000,000
1.ROI = Operating Income/Average Assets	7.88%
Margin = Operating Income/Sales	10.50%
Turnover = Sales/Average Assets	0.75
ROI increased as operating assets decreased without any change in operating income
4.
	Year 4
Sales	10,000,000
Operating Income	1,200,000
Average Assets	12,000,000
1.ROI = Operating Income/Average Assets	10.00%
Margin = Operating Income/Sales	12.00%
Turnover = Sales/Average Assets	0.83
ROI increased as operating income increased and average assets decreased