Question

Problem 2 — COMPUTATION OF RETURN ON INVESTMENT (ROI)

For the year ended December 31, 2017, Reese Company reports the following:

            Sales                                                          $6,000,000

            Variable costs                                              3,200,000

            Controllable fixed costs                               2,000,000

            Average operating assets                             5,000,000

Instructions: Compute ROI for each of the following situations. Show all computations.

1.   For the year ended December 31, 2017.

2.   For 2018 assuming the following independent courses of action:

      (a)   Sales will increase 10% with no change in the contribution margin ratio.

      (b)   Variable costs and controllable fixed costs will both be reduced 10%.

      (c)   Average operating assets will be reduced 20%.

SOLUTION

1.     $800,000/$5,000,000 = 16%                                        Sales                             $6,000,000

                                                                                                Var costs                      3,200,000

2.                                                                                             Contribution margin            2,800,000

(a)                                                                                            Controllable FC        2,000,000

           Sales            6,600,000                                     Controllable margin           $ 800,000

        Var costs                                                                       

        Cont margin     3,080,000 rounded ($6.6m *46.6667%)      CM ratio=$2.8m / $6m =46.6667%

     Controllable FC 2,000,000          

     Controllable M    1,080,000               $1,080,000 / $5000,000 = 21.6%

(b)   Sales                   $6,000,000

       Var costs             - 2,880,000

Contribution margin     3,120,000      

Fixed costs                 - 1,800,000                    $1320,000 / $500,000 26.4%

Controllable margin    $1,320,000

(c) $800,000/($5,000,000 - $1,000,000) = 20%

Controllable Costs -Costs that can be influenced or changed by management. Only focus on controllable costs in making decisions (non-controllable costs will be the same regardless of your decision)

Answer 1