For Year 1, Division C of Deerfield Company reported operating assets of $8,800,
ID: 2570408 • Letter: F
Question
For Year 1, Division C of Deerfield Company reported operating assets of $8,800,000, revenues of $6,600,000, and operating expenses of $5,760,000. The company has established a target return on investment (ROI) of 10% for the division.
Required: 1) Calculate the Year 1 ROI for the division. Did the division achieve its target ROI for the year?
2) For Year 2, Division C managers expect that its operating assets will stay at about the same level as for Year 1. Variable expenses for Year 1 were $3,960,000, and the remaining expenses were fixed. The managers expect that the contribution margin ratio for Year 2 will be the same as for Year 1 and that the amount of fixed expenses will not change. To what level must sales increase in Year 2 to achieve the target ROI?
Explanation / Answer
Solution:
Part 1)
ROI = Net Operating Income / Operating Assets x 100
Net Operating Income = Operating Revenue – Expenses = 6600,000 – 5760,000 = $840,000
ROI = 840,000 / 8800,000 x 100 = 9.55%
No, the dividend did not achieve its target ROI.
Part 2)
Operating Assets (Same) = $8800,000
Variable Expenses = $3,960,000
Fixed Expenses = $5760,000 – 3960,000 = $1800,000
Target ROI = Operating Assets 8800,000 * Target ROI 10% = $880,000
Contribution Margin Ratio = Contribution Margin / Total Sales Revenue x 100
Contribution Margin = Total Sales – Total Variable Expenses = $6600,000 - $3960,000 = $2640,000
Contribution Margin Ratio = Contribution Margin 2640,000 / Total Sales Revenue 6600,000 x 100 = 40%
Total Sales Required to achieve the target ROI = (Total Fixed Expenses + Target Return) / Contribution Margin Ratio
= (1800,000 + $880,000) / 40%
= $6700,000
Increase in Sales = Sales Required to achieve target ROI – Sales Year 1
= 6700,000 – 6600,000
= $100,000
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