Question

You are the operations manager for a small kayak and canoe manufacturer (Valley Kayaks) located on the Pacific Northwest (Oregon). Lately your company has experienced product quality problems. Simply put, the kayaks that you produce occasionally have defects and require rework. Consequently, you have decided to assess the impact of introducing a total quality management (TQM) program. After discussing the potential effects with representatives from marketing, finance, accounting, and quality, you arrive at a set of estimates (contained in the following table). Top management has told you that they will accept any proposal that you come up with PROVIDED that it improves the return on assets measure by at least 25 percent. Use Figure 2.3.

Category	Current Values			Estimated Impact of TQM
Sales	$	4,056,000			6	%	+ (improvement)
Cost of goods sold	$	3,120,000			0	%
Variable expenses	$	520,000			7.50	%	− (reduction)
Fixed expenses	$	202,800			0	%
Inventory	$	393,000			30	%	−
Accounts receivable	$	342,000			0	%
Other current assets	$	675,000			0	%
Fixed assets	$	663,000			0	%

a) Calculate the ROA (return on assets) with changes AND without changes.

b) Would you go forward with this proposal to improve quality, YES or NO?

Answer 1

a) Return on Assets = Net income/average total assets or Net income/ending period total assets

Question doesn't have data for beginning period. so instead of using average total assets, ending period total assets need to be used.

ROA without changes:

Net income = Sales - cost of goods sold - variable expenses - fixed expenses

Net income = $4,056,000 - $3,120,000 - $520,000 - $202,800 = $213,200

Total assets = Inventory + Accounts receivable + other current assets + Fixed assets

Total assets = $393,000 + $342,000 + $675,000 + $663,000 = $2,073,000

ROA without changes = $213,200/$2,073,000 = 10.28%

ROA with changes:

New Sales with 6% increase = $4,056,000*1.06 = $4,299,360

New variable expenses with 7.5% reduction = $520,000*(1-0.075) = $520,000*0.925 = $481,000

New Inventory with 30% reduction = $393,000*(1-0.30) = $393,000*0.70 = $275,100

Net income = $4,299,360 - $3,120,000 - $481,000 - $202,800 = $495,560

Total assets = $275,100 + $342,000 + $675,000 + $663,000 = $1,955,100

ROA with changes = $495,560/$1,955,100 = 25.35%

b) Yes, would go forward with this proposal to improve quality because it increases ROA by 15.07% (25.35% - 10.28%).