Question

Profit Margin, investment turnover, and return on investment The condensed income statement for the Consumer Products Division of Fargo Industries Inc. is as follows (assuming no service department charges): Sales $82,500,000 Cost of goods sold 53,625,000 Gross profit $28,875,000 Administrative expenses 15,675,000 Income from operations $13,200,000 The manager of the Consumer Products Division is considering ways to increase the return on investment. a. Using the DuPont formula for return on investment, determine the profit margin, investment turnover, and return on investment of the Consumer Products Division, assuming that $55,000,000 of assets have been invested in the Consumer Products Division. If required, round the investment turnover to one decimal place. Profit margin 16 % Investment turnover 1.5 Return on investment 24 % b. If expenses could be reduced by $1,650,000 without decreasing sales, what would be the impact on the profit margin, investment turnover, and return on investment for the Consumer Products Division? If required, round the investment turnover to one decimal place. Profit margin % Investment turnover Return on investment %

Answer 1

Solution:

a. Using the DuPont formula for return on investment

Rate of return on investment

= Income from operations / Invested assets X 100

= $13,200,000 / $55,000,000 X 100

=24%

Rate of return on investment = profit margin x investment turnover

a. Profit margin

=Income from operations / sales X 100

=$13,200,000 / $82,500,000 X 100

= 16%

b. Investment turnover

=Sales / invested assets

=$82,500,000 / $55,000,000

= 1.5

c. Rate of return on investment

= Profit margin x investment turnover

= 16% X 1.5

=24%

b. If expenses could be reduced by $1,650,000 without decreasing sales, what would be the impact on the profit margin, investment turnover, and return on investment for the Consumer Products Division?

Particulars	Amount ($)
Sales	82,500,000
Cost of goods sold	53,625,000
Gross profit	28,875,000
Administrative expenses($15,675,000-$ 1,650,000)	14,025,000
Income from operations	$ 14,850,000

a. Profit margin

=Income from operations / sales X 100

=$ 14,850,000/ $82,500,000 X 100

= 18%

b. Investment turnover

=Sales / invested assets

=$82,500,000 / $55,000,000

= 1.5

c. Rate of return on investment

= Profit margin x investment turnover

= 18% X 1.5

=27%

OR

Rate of return on investment

= Income from operations / Invested assets X 100

= $ 14,850,000/ $55,000,000 X 100

=27%

Analysis of Result

Because of reduction in expenses profit margin increased by 2% (from 16% to 18%), while investment turnover is unaffected at 1.5. Rate of return increased by 3% (from 24% to 27%).

	Before reduction in expenses	After reduction in expenses	Increase or Decrease
Profit margin	16%	18%	2 % Increase
Investment turnover	1.5	1.5	No effect
Rate of return on investment	24%	27%	3 % Increase