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Managerial Accounting: The Corners...
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Managerial Accounting: The Corners...
Return on Investment, Margin, Turnover
Ready Electronics is facing stiff competition from imported goods. Its operating income margin has been declining steadily for the past several years. The company has been forced to lower prices so that it can maintain its market share. The operating results for the past 3 years are as follows:
For the coming year, Ready’s president plans to install a JIT purchasing and manufacturing system. She estimates that inventories will be reduced by 70% during the first year of operations, producing a 20% reduction in the average operating assets of the company, which would remain unchanged without the JIT system. She also estimates that sales and operating income will be restored to Year 1 levels because of simultaneous reductions in operating expenses and selling prices. Lower selling prices will allow Ready to expand its market share. (Note: Round all numbers to two decimal places.)
Required:
- 1. Compute the ROI, margin, and turnover for Years 1, 2, and 3.
- 2. CONCEPTUAL CONNECTION Suppose that in Year 4 the sales and operating income were achieved as expected, but inventories remained at the same level as in Year 3. Compute the expected ROI, margin, and turnover. Explain why the ROI increased over the Year 3 level.
- 3. CONCEPTUAL CONNECTION Suppose that the sales and net operating income for Year 4 remained the same as in Year 3 but inventory reductions were achieved as projected. Compute the ROI, margin, and turnover. Explain why the ROI exceeded the Year 3 level.
- 4. CONCEPTUAL CONNECTION Assume that all expectations for Year 4 were realized. Compute the expected ROI, margin, and turnover. Explain why the ROI increased over the Year 3 level.
1.
Calculate ROI, margin, and turnover for Year 1, 2, and 3.
Return on Investment (ROI):
Return on investment can be defined as the amount of profit earned by the company on per dollar of investment. It can be computed by dividing operating income by the average operating assets.
Margin:
The ratio of operating income to the amount of sales revenue is known as margin. It represents the proportion of sales revenue left for taxes, interest, and profit.
Turnover:
Turnover can be defined as the amount of dollar sales earned by the company from investing every dollar in the operating assets. It is computed by dividing the amount of sales by the average operating assets.
The following table represents the calculation of return on investment:
| Year 1 ($) | Year 2 ($) | Year 3 ($) | |
| Operating income (A) | 1,200,000 | 1,045,000 | 945,000 |
| Average assets (B) | 15,000,000 | 15,000,000 | 15,000,000 |
| Return on investment | 0.08 or 8.00% | 0.0697 or 6.97% | 0.063 or 6.30% |
Table (1)
The ROI of Year 1, 2, and 3 are 8%, 6.97%, and 6.30%
2.
Calculate the expected ROI, margin, and turnover for Year 4.
3.
Calculate the expected ROI, margin, and turnover for Year 4 when the amount of inventory reduces.
4.
Calculate the expected ROI, margin, and turnover for Year 4 while assuming all the expectations.
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