Sorrento Corporation’s balance sheet indicates that the company has $500,000 inv

Question

Sorrento Corporation’s balance sheet indicates that the company has $500,000 invested in operating assets. During 2018, Sorrento earned operating income of $50,000 on $1,000,000 of sales. Required Compute Sorrento’s profit margin for 2018. Compute Sorrento’s turnover for 2018. Compute Sorrento’s return on investment for 2018. Recompute Sorrento’s ROI under each of the following independent assumptions: (1) Sales increase from $1,000,000 to $1,200,000, thereby resulting in an increase in operating income from $50,000 to $56,000. (2) Sales remain constant, but Sorrento reduces expenses, resulting in an increase in operating income from $50,000 to $52,000. (3) Sorrento is able to reduce its invested capital from $500,000 to $400,000 without affecting operating income.

Explanation / Answer

Answer:

Profit Margin = Net Operating Income / Sales * 100
Profit Margin = 50,000 / 1,000,000 * 100
Profit Margin = 5%

Turnover Ratio = Sales / Operating Assets
Turnover Ratio = 1,000,000 / 500,000
Turnover Ratio = 2 times

Return on Investment = Net Operating Income / Operating Assets
Return on Investment = 50,000 / 500,000
Return on Investment = 10%

Situation 1: Sales increase from $1,000,000 to $1,200,000, thereby resulting in an increase in operating income from $50,000 to $56,000

Profit Margin = Net Operating Income / Sales * 100
Profit Margin = 56,000 / 1,200,000 * 100
Profit Margin = 4.67%

Turnover Ratio = Sales / Operating Assets
Turnover Ratio = 1,200,000 / 500,000
Turnover Ratio = 2.4 times

Return on Investment = Net Operating Income / Operating Assets
Return on Investment = 56,000 / 500,000
Return on Investment = 11.20%

Situation 2: Sales remain constant, but Sorrento reduces expenses, resulting in an increase in operating income from $50,000 to $52,000.

Profit Margin = Net Operating Income / Sales * 100
Profit Margin = 52,000 / 1,000,000 * 100
Profit Margin = 5.20%

Turnover Ratio = Sales / Operating Assets
Turnover Ratio = 1,000,000 / 500,000
Turnover Ratio = 2 times

Return on Investment = Net Operating Income / Operating Assets
Return on Investment = 52,000 / 500,000
Return on Investment = 10.40%

Situation 3: Sorrento is able to reduce its invested capital from $500,000 to $400,000 without affecting operating income

Profit Margin = Net Operating Income / Sales * 100
Profit Margin = 50,000 / 1,000,000 * 100
Profit Margin = 5%

Turnover Ratio = Sales / Operating Assets
Turnover Ratio = 1,000,000 / 400,000
Turnover Ratio = 2.5 times

Return on Investment = Net Operating Income / Operating Assets
Return on Investment = 50,000 / 400,000
Return on Investment = 12.50%

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