Question

As the operations manager for Valley Kayaks (as described in the previous problem), you find yourself faced with an interesting situation. Marketing has informed you that they have lost a number of sales because of a lack of inventory. Kayaks, being seasonal in nature, have to be in stock at your dealers if they are to be sold (customers are not willing to wait). The director of marketing proposes that you increase inventories by 15 percent (a major investment to you). She has also given the information in the following table. Use Figure 2.3.

Category	Current Values			Proposed Impact of Inventory Increase
Sales	$	3,570,000			35	%	+ (improvement)
Cost of goods sold	$	2,550,000			0	%
Variable expenses	$	510,000			10	%	− reduction
Fixed expenses	$	178,500			15	%	+ (increase)
Inventory	$	470,000			15	%	+
Accounts receivable	$	117,000			0	%
Other current assets	$	560,000			0	%
Fixed assets	$	555,000			0	%

a) Using the information given above what is the Total Return on Assets in PERCENT (%) for the Current Values column?

b) What would the NEW values be for the above table, given the proposed impact of inventory increase (NOT IN PERCENT!)?

c) What is the total Return on Assets for the NEW values (IN PERCENT %)?

d) Would the projected change in Return on Assets justify the inventory investment?

Answer 1

Part a

Total return on asset ROA = total earnings/ total assets

Total earnings = sales - cost of goods sold - variable cost - fixed cost

= 3570000 -2550000-510000-178500 =331500

Tital assets = fixed asset +current assets =555000 +470000+117000+560000 = 1702000

ROA = 331500/1702000 = 19.48%

Part b the new values are as follows

Sales = 3570000 ×1.35 = 4819500

Variables expanses = 510000 × .90 = 459000

Fixed expenses = 178500× 1.15= 205275

Inventories = 470000× 1.15 = 540500

Part c

Total earnings = 4819500 - 2550000-459000-205275 = 1605225

Total assets = 540500+117000+560000+555000 =1772500

ROA = 1605225/1772500 =90.56%

Part d

Numbers shows that it justifies the increase in inventories as it increases ROA by a significant margin of =1.9056/1.1948 -1 = 59.49% however it may be surprising that just 15% increase in inventory can increase the ROA this much but is possible due three reasons

First increased volume of sales

Second economics of scale i.e. reduced cost

Third if investories is being increased thrn it means that there must be a good demand potential for the product resulting sale price might also have been increased.