Question

Effect of Proposals on Divisional Performance

A condensed income statement for the Electronics Division of Gihbli Industries Inc. for the year ended December 31, 20Y9, is as follows:

Sales	$1,575,000
Cost of goods sold	891,000
Gross profit	$684,000
Operating expenses	558,000
Income from operations	$126,000
Invested assets	$1,050,000

Assume that the Electronics Division received no charges from service departments.

The president of Gihbli Industries Inc. has indicated that the division's return on a $1,050,000 investment must be increased to at least 20% by the end of the next year if operations are to continue. The division manager is considering the following three proposals:

Proposal 1: Transfer equipment with a book value of $300,000 to other divisions at no gain or loss and lease similar equipment. The annual lease payments would be less than the amount of depreciation expense on the old equipment by $31,400. This decrease in expense would be included as part of the cost of goods sold. Sales would remain unchanged.

Proposal 2: Reduce invested assets by discontinuing a product line. This action would eliminate sales of $180,000, reduce cost of goods sold by $119,550, and reduce operating expenses by $60,000. Assets of $112,500 would be transferred to other divisions at no gain or loss.

Proposal 3: Purchase new and more efficient machinery and thereby reduce the cost of goods sold by $189,000 after considering the effects of depreciation expense on the new equipment. Sales would remain unchanged, and the old machinery, which has no remaining book value, would be scrapped at no gain or loss. The new machinery would increase invested assets by $918,750 for the year.

Required:

1. Using the DuPont formula for return on investment, determine the profit margin, investment turnover, and return on investment for the Electronics Division for the past year. If required, round your answers to one decimal place.

	Electronics Division
Profit margin		%
Investment turnover
ROI		%

Feedback

1. Income from operations divided by sales equals profit margin. Sales divided by invested assets equals investment turnover. Multiply these two values for the rate of return on investment.

Learning Objective 4.

2. Prepare condensed estimated income statements and compute the invested assets for each proposal.

Gihbli Industries Inc.-Electronics Division
Estimated Income Statements
For the Year Ended December 31, 20Y9
	Proposal 1	Proposal 2	Proposal 3
Sales	$	$	$
Cost of goods sold
Gross profit	$	$	$
Operating expenses
Income from operations	$	$	$
Invested assets	$	$	$

Feedback

2. For each proposal, subtract operating expenses from gross profit.

Learning Objective 4.

3. Using the DuPont formula for return on investment, determine the profit margin, investment turnover, and return on investment for each proposal. Round investment turnover and percentages to one decimal place.

Proposal	Profit margin	Investment turnover	ROI
Proposal 1	%		%
Proposal 2	%		%
Proposal 3	%		%

4. Which of the three proposals would meet the required 20% rate of return on investment?

Proposal 1	Meets
Proposal 2	Does not meet
Proposal 3	Does not meet

5. If the Electronics Division were in an industry where the profit margin could not be increased, how much would the investment turnover have to increase to meet the president's required 20% rate of return on investment? Enter your increase in investment turnover answer as a percentage of current investment turnover. Round interim calculations (including previously calculated) and final answer to one decimal place.
%

Answer 1

1. ROI
Profit Margin (%)	8.00%
(Net Profit/Sales)	(1,26,000/15,75,000)
Investment T.O
(Sales/Total assets)
Sales	15,75,000
Total Assets	10,50,000
Investment T.O	1.50
ROI (%)
Profit Margin * Assets TO	12%
2. Proposal Analysis
		Proposal 1	Proposal 2	Proposal 3
Sales	(A)	15,75,000	13,95,000	15,75,000
			(15,75,000-1,80,000)
Cost of Goods Sold		859600	7,71,450	7,02,000
		(8,91,000-31,400)	(8,91,000-1,19,550)	(8,91,000-1,89,000)
Gross Profit	(B)	7,15,400	6,23,550	8,73,000
Operating Expenses		558000	498000	558000
			(5,58,000-60,000)
Income From operations	('C)	1,57,400	1,25,550	3,15,000
Invested Assets	(D)	7,50,000	9,37,500	19,68,750
		(10,50,000-3,00,000)	(10,50,000-1,12,500)	(10,50,000+9,18,750)
3, DuPont Analysis
Profit Margin	('E)	9.99%	9.00%	20.00%
(C/A)
Investment Turnover
(A/D)	(F)	2.10	1.49	0.80
ROI (E*F)		20.99%	13.39%	16.00%
4. Only Proposal 1 meet the ROI exceeding 20%
5
Profit Margin	8%
Desired ROI	20%
Desired Investment Turnover	2.5
Existing Investment Turnover	1.5
Increase (%)
(2.5-1.5)1.5	66.7%