Question

The contribution format income statement for Huerra Company for last year is given below:

	Total		Unit
Sales	$	4,000,000	$	80.00
Variable expenses		2,800,000		56.00
Contribution margin		1,200,000		24.00
Fixed expenses		840,000		16.80
Net operating income		360,000		7.20
Income taxes @ 30%		108,000		2.16
Net income	$	252,000	$	5.04

The company had average operating assets of $2,000,000 during the year.

Required:

1. Compute the company’s return on investment (ROI) for the period using the ROI formula stated in terms of margin and turnover. (Round your answers to 2 decimal place.)

For each of the following questions, indicate whether the margin and turnover will increase, decrease, or remain unchanged as a result of the events described, and then compute the new ROI figure. Consider each question separately, starting in each case from the data used to compute the original ROI in (1) above.

2. Using Lean Production, the company is able to reduce the average level of inventory by $400,000. (The released funds are used to pay off short-term creditors.) (Round your answers to 2 decimal places.)

3. The company achieves a cost savings of $32,000 per year by using less costly materials. (Round your answers to 2 decimal places.)

4. The company issues bonds and uses the proceeds to purchase $500,000 in machinery and equipment at the beginning of the period. Interest on the bonds is $60,000 per year. Sales remain unchanged. The new, more efficient equipment reduces production costs by $20,000 per year. (Round your answers to 2 decimal places.)

5. Sales are increased by 20%; operating assets remain unchanged. (Round your answers to 2 decimal places.)

6. Obsolete inventory carried on the books at a cost of $40,000 is scrapped and written off as a loss. (Round your answers to 2 decimal places.)

7. The company uses $200,000 of cash (received on accounts receivable) to repurchase and retire some of its common stock. (Round your answers to 2 decimal places.)

Answer 1

5)

Sales ( 4000,000 x 1.20)	4800000
(-) variable cost ( 2800000*1.20)	-3360000
New contribution margin	1440000
(-) Fixed cost	-840000
Net operating income	600000
(-) Taxes 30%	-180000
Net Income	420000

Margin = net operating income/ sales

                = 600,000/480,000

                = 12.50% increased

Turnover = sales/ assets

                    = 4800000/2000,000

                     =2.40 increased

6)

It will decrease operating income by 40,000

Margin = net operating income/ sales

                = (360,000-40,000)/4000, 000

                = 8%

Turnover = 4000, 000/(2000,000-40,000)

                = 2.04 increased.

7) It will reduce assets by 200,000.

Margin = 9% unaffected.

Turnover = 4000, 000/(2000,000-200,000)

                   = 2.22 increased