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Effect of proposals on divisional performance A condensed income statement for the Electronics Division of Gihbli Industries Inc. for the year ended December 31, 20Y9, is as follows: Sales $1,575,000 Cost of goods sold 891,000 Gross profit $684,000 Operating expenses 558,000 Income from operations $126,000 Invested assets $1,050,000 Assume that the Electronics Division received no charges from service departments. The president of Gihbli Industries Inc. has indicated that the division's return on a $1,050,000 investment must be increased to at least 20% by the end of the next year if operations are to continue. The division manager is considering the following three proposals: Proposal 1 : Transfer equipment with a hook value of $300,000 to other divisions at no gain or loss and lease similar equipment. The annual lease payments would be less than the amount of depreciation expense on the old equipment by $31,400. This decrease in expense would be included as part of the cost of goods sold. Sales would remain unchanged. Proposal 2: Reduce invested assets by discontinuing a product line. This action would elim­inate sales of $180,000, reduce cost of goods sold by $119,550, and reduce operating expenses by $60,000. Assets of $112,500 would be transferred to other divisions at no gain or loss. Proposal3: Purchase new and more efficient machinery and thereby reduce the cost of goods sold by $189,000 after considering the effects of depreciation expense on the new equipment. Sales would remain unchanged, and the old machinery, which has no remaining book value, would be scrapped at no gain or loss. The new machinery would increase invested assets by $918,750 for the year. Instructions 1. Using the DuPont formula for return on investment, determine the profit margin, investment turnover, and return on investment for the Electronics Division for the past year. (Round percentages and investment turnover to one decimal place.) 2. Prepare condensed estimated income statements and compute the invested assets for each proposal. 3. Using the DuPont formula for return on investment, determine the profit margin, investment turnover, and return on investment for each proposal. (Round percentages and investment turnover to one decimal place.) 4. Which of the three proposals would meet the required 20% return on investment? 5. If the Electronics Division were in an industry where the profit margin could not be increased, how much would the investment turnover have to increase to meet the president’s required 20% return on investment? (Round to one decimal place.)

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Financial & Managerial Accounting

14th Edition
Carl Warren + 2 others
Publisher: Cengage Learning
ISBN: 9781337119207

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Chapter
Section
BuyFindarrow_forward

Financial & Managerial Accounting

14th Edition
Carl Warren + 2 others
Publisher: Cengage Learning
ISBN: 9781337119207
Chapter 23, Problem 23.4BPR
Textbook Problem
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Effect of proposals on divisional performance

A condensed income statement for the Electronics Division of Gihbli Industries Inc. for the year ended December 31, 20Y9, is as follows:

Sales $1,575,000
Cost of goods sold 891,000
Gross profit $684,000
Operating expenses 558,000
Income from operations $126,000
Invested assets $1,050,000

Assume that the Electronics Division received no charges from service departments.

The president of Gihbli Industries Inc. has indicated that the division's return on a $1,050,000 investment must be increased to at least 20% by the end of the next year if operations are to continue. The division manager is considering the following three proposals:

Proposal 1: Transfer equipment with a hook value of $300,000 to other divisions at no gain or loss and lease similar equipment. The annual lease payments would be less than the amount of depreciation expense on the old equipment by $31,400. This decrease in expense would be included as part of the cost of goods sold. Sales would remain unchanged.

Proposal 2: Reduce invested assets by discontinuing a product line. This action would elim­inate sales of $180,000, reduce cost of goods sold by $119,550, and reduce operating expenses by $60,000. Assets of $112,500 would be transferred to other divisions at no gain or loss.

Proposal3: Purchase new and more efficient machinery and thereby reduce the cost of goods sold by $189,000 after considering the effects of depreciation expense on the new equipment. Sales would remain unchanged, and the old machinery, which has no remaining book value, would be scrapped at no gain or loss. The new machinery would increase invested assets by $918,750 for the year.

Instructions

  1. 1. Using the DuPont formula for return on investment, determine the profit margin, investment turnover, and return on investment for the Electronics Division for the past year. (Round percentages and investment turnover to one decimal place.)
  2. 2. Prepare condensed estimated income statements and compute the invested assets for each proposal.
  3. 3. Using the DuPont formula for return on investment, determine the profit margin, investment turnover, and return on investment for each proposal. (Round percentages and investment turnover to one decimal place.)
  4. 4. Which of the three proposals would meet the required 20% return on investment?
  5. 5. If the Electronics Division were in an industry where the profit margin could not be increased, how much would the investment turnover have to increase to meet the president’s required 20% return on investment? (Round to one decimal place.)

(1)

To determine

Profit margin: This ratio gauges the operating profitability by quantifying the amount of income earned from business operations from the sales generated.

Formula of profit margin:

Profit margin=Income from operationsSales

Investment turnover: This ratio gauges the operating efficiency by quantifying the amount of sales generated from the assets invested.

Formula of investment turnover:

Investment turnover=SalesInvested assets

Return on investment (ROI): This financial ratio evaluates how efficiently the assets are used in earning income from operations. So, ROI is a tool used to measure and compare the performance of a units or divisions or a companies.

Formula of ROI according to Dupont formula:

Return on investment = Profit margin × Investment turnover=Income from operationsSales×SalesInvested assets=Income from operationsInvested assets

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

To determine: Profit margin, investment turnover, and return on investment of E Division

Explanation of Solution

Determine ROI of E Division, if income from operations is $126,000, sales are $1,575,000, and assets invested are $1,050,000.

Return on investment =          Profit margin         ×    Investment turnover=Income from operationsSales×SalesInvested assets=$126,000$1,575,000×

(2)

To determine

To prepare: The income statements for E Division of Company M for the year ended December 31, for each of the three proposals, and compute invested assets for each proposal

(3)

To determine
Profit margin, investment turnover, and return on investment of E Division under the three proposals

(4)

To determine

To indicate: The proposal which meets the desired ROI of 20%

(5)

To determine
The increase in investment turnover to meet the desired return of 20%

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Chapter 23 Solutions

Financial & Managerial Accounting
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