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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

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.

 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?

(a)

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

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

Explanation

Determine ROI of CP Division, if income from operations is $13,200,000, and sales are $82,500,000, and assets invested are $55,000,000.

Return on investment =          Profit margin         ×    Investment turnover=Income from operationsSales×SalesInvested assets=$13,200,000$82,500,000×

(b)

To determine
Revised profit margin, investment turnover, and revised return on investment of CP Division, if the expenses are reduced by $1,650,000, and write the impact of reduced expenses on ROI

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