1. If the sales and average invested capital remain the same during the next yea

Question

1. If the sales and average invested capital remain the same during the next year, to what level would total expenses have to be reduced in order to improve the firm’s ROI to 15 percent?

2-a. Assuming that the expenses and cost of goods sold are reduced in order to improve the firm's ROI to 15 percent, compute the firm's new sales margin.

2-b. Show how the new sales margin and the old capital turnover together result in a new ROI of 15 percent.

Required information The following information applies to the questions displayed below. The following data pertain to British Isles Aggregates Company, a producer of sand, gravel, and cement, for the year just ended Sales revenue Cost of goods sold Operating expenses Average invested capital E6,900,000 2,928,000 3,696,000 3,450,000 S denotes the British pound sterling, the national monetary unit of Great Britain.

Explanation / Answer

Solution 1:

Required ROI = 15%

Therefore required net operating income = 3,450,000 Pound * 15% = 517,500 Pound

Existing net operating income = 6,900,000 - 2,928,000 - 3,696,000 = 276,000 Pound

Required reduction in total expenses = 517500 - 276000 = 241,500 Pound

Solution 2a:

Firm's new sales marging = Net operating income /Sales = 517,500 / 6,900,000 = 7.50%

Solution 2b:

Old captial turnover ratio = Sales / Average invested captial = 6,900,000 / 3,450,000 = 2 times

New ROI = New sales Margin * Old capital turnover = 7.50%*2 = 15%

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