Question

Principal Skinner Company produces gourmet cheeses. Selected results from the most current year were as follows:

                             Sales revenue                               $3,500,000

                             Operating income                           560,000

                             Assets 1/1                                     5,000,000

                             Assets 12/31                                5,800,000

                             Current liabilities 12/31               925,000

                             Long-term Liabilities 12/31      3,050,000

Production manager Marge Simpson is considering investing in the purchase of a new fermenting station that will increase the plant’s production capacity. Based on her research, Marge thinks the station would cost $2,200,000 and would increase sales revenue by $1,750,000 and operating income by $450,000.

Required

1. Calculate Principal Skinner’s current sales margin, asset turnover, and return on investment.
2. Calculate Principal Skinner’s sales margin, asset turnover, and return on investment assuming the company purchases the new fermenting station.
3. Assume Marge Simpson’s annual bonus is based on the company’s return on investment. Will Marge support the purchase of the new fermenting station? Why or why not?

Answer 1

Answer:

1. Calculate Principal Skinner’s current sales margin, asset turnover, and return on investment.

Sales Margin	16.00%
Turonver	0.65
ROI	10.37%

2. Calculate Principal Skinner’s sales margin, asset turnover, and return on investment assuming the company purchases the new fermenting station.

Sales Margin	19.24%
Turonver	0.69
ROI	13.29%

3. Assume Marge Simpson’s annual bonus is based on the company’s return on investment. Will Marge support the purchase of the new fermenting station? Why or why not?

Yes

Melinda will support the purchase of the fermenting station.

It is because investing in the purchase of a new fermenting station that will increase the plant’s production capacity and also will increase the Return on investments

Calculation:

1.

Sales margin is the profit generated from the sale of the product or service provided. Here we need to divide the operating income with the Sales revenue to get the Sales margin.

Sales Margin = Operating Income / Sales Revenue = 560,000 / 3,500,000 = 16%

Asset turnover ratio is used to see how effectively companies use the assets to generate sales. Here we need to divide the Sales revenue with Average Assets.

So first we need to calculate the average total assets.

Average total assets = (5,000,000 + 5,800,000) / 2 = 5,400,000

Then, Asset turnover ratio = Sales Revenue / Average total assets = 3,500,000 / 5,400,000 = 0.648 times

Return on investment (ROI) ratio is used to calculate the benefit an investor will receive for an investment. Here we could calculate that by multiplying the Sales margin and Turnover ratio.

Return on investment = Sales margin x Turnover ratio = 16% x 0.65 = 10.37%

2.

The station would cost $2,200,000 and would increase sales revenue by $1,750,000 and operating income by $450,000.

Sales margin is the profit generated from the sale of the product or service provided. Here we need to divide the operating income with the Sales revenue to get the Sales margin.

Sales Margin = Operating Income + increase operating profit / Sales Revenue + increase sales revenue = 560,000 + 450,000 / 3,500,000 +1,750,000 = 19.24%

Asset turnover ratio is used to see how effectively companies use the assets to generate sales. Here we need to divide the Sales revenue with Average Assets.

So first we need to calculate the average total assets.

Average total assets = (5,000,000 + 5,800,000) / 2 = 5,400,000

Then, Asset turnover ratio = Sales Revenue + increase sales revenue / Average total assets + Increase in cost = 3,500,000 +1,750,000 / 5,400,000 + 2,200,000  = 0.691 times

Return on investment (ROI) ratio is used to calculate the benefit an investor will receive for an investment. Here we could calculate that by multiplying the Sales margin and Turnover ratio.

Return on investment = Sales margin x Turnover ratio = 19.24% x 0.69 = 13.29%