Return on Investment, Margin, Turnover Ready Electronics is facing stiff competi

Question

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: Year 1 Year 2 Year 3 Sales $14,500,000 $ 9,500,000 $ 9,000,000 Operating income 1,200,000 1,345,000 945,000 Average assets 15,000,000 15,000,000 15,000,000 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. Year 1 Year 2 Year 3 ROI 0.77 % 0.09 % 0.06 % Margin 0.08 % 0.01 % 0.10 % Turnover 0.97 0.63 0.6 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. ROI % Margin % Turnover Why did the ROI increase 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. ROI % Margin % Turnover Why did the ROI exceed the Year 3 level? 4. Conceptual Connection: Assume that all expectations for Year 4 were realized. Compute the expected ROI, margin, and turnover. ROI % Margin % Turnover Why did the ROI increase over the Year 3 level?

Explanation / Answer

Data given in question

Year

1

2

3

Sales

14500000

9500000

9000000

Operating Income

1200000

1345000

945000

Average assets

15000000

15000000

15000000

Answer

1:

Calculation formula

Year 1

Year2

Year 3

ROI

Operating Income/Average Assets

0.08

0.090

0.06

Margin

Operating Income /Sales

0.08

0.14

0.11

Turnover ratio

Sales/Average Assets

0.97

0.63

0.6

2: Conceptual connection

Year 4 : Sales = 14500000, Operating Income = 1200000, Average Assets = 15000000

ROI= Operating Income/Average Assets = 1200000/15000000 = 0.08

Margin = Operating income/Sales = 1200000/14500000 = 0.08

Turnover ratio :Sales/Average Assets = 14500000/15000000 = 0.97

The ROI has increased in year 4 over the 3rd Year’s ROI because Operating income is increased but inventory were same . So we are earning more amount of profit from the same level of investment which is the reason of increase in ROI.

3. Conceptual connection

Year 4 : Sales = 9000000, Operating Income = 945000, Average Assets = 12000000

ROI= Operating Income/Average Assets = 945000/12000000 = 0.08

Margin = Operating income/Sales = 945000/9000000 = 0.11

Turnover ratio :Sales/Average Assets = 9000000/12000000 = 0.75

The ROI has exceeded level of year 3 because operating profit is same but the investment in assets is lower under year 4. So we are able to earn same amount i.e. 945000 by investing lesser. The same return of profit with lower investment has increased the ROI.

4. Conceptual Connection

Year 4 : Sales = 14500000, Operating Income = 1200000, Average Assets = 12000000

ROI= Operating Income/Average Assets = 1200000/12000000 = 0.10

Margin = Operating income/Sales = 1200000/14500000 = 0.08

Turnover ratio :Sales/Average Assets = 14500000/12000000 = 1.21

The ROI has exceeded the level of year 3 because operating profit is increased at the same time the investment in assets is also decresed. So we are able to earn more amount by investing lesser. So there are two factors which has increased ROI first is more operating income and second the lower investment. We are able to earn more with lesser investment.

Year

1

2

3

Sales

14500000

9500000

9000000

Operating Income

1200000

1345000

945000

Average assets

15000000

15000000

15000000

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