The contribution format income statement for Huerra Company for last year is giv

Question

The contribution format income statement for Huerra Company for last year is given below: Sales 992,000 49.60 95,200 29.76 Contribution margin Fixed expenses Net operating income Income taxes e 40 Net income 396, 800 19.84 318,800 15.94 .90 31,200 1.56 $ 46,800 2.34 78,000 The company had average operating assets of $495,000 during the year. Required: 1. Compute the company's returm on investment (ROD for the period using the ROI formula stated in terms of margin and turnover For each of the following questions, indicate whether the margin and turnover will increase, decrease, or remain unchanged as a result of the events described, and then compute the new ROl figure. Consider each question separately, starting in each case from the data used to compute the original ROI in () above. 2. Using Lean Production. the company is able to reduce the average level of inventory by $104,000. (The released funds are used to pay off short-term creditors) 3. The company achieves a cost savings of $13,000 per year by using less costly materials 4. The company issues bonds and uses the proceeds to purchase machinery and equipment that increases average operating assets by $124,000. Interest on the bonds is $11.000 per year. Sales remain unchanged. The new, more efficient equipment reduces production costs by $8,000 per year 5. Sales are increased by 15%, operating assets remain unchanged. 6. At the beginning of the year, obsolete inventory carried on the books at a cost of $16,000 is scrapped and written off as a loss. 7. At the beginning of the year, the company uses $182.000 of cash (received on accounts receivable) to repurchase and retire some of its common stock 19

Explanation / Answer

Answer to Requirement No. 5:

If Sales are Increased by 15%, then the New Sales will be $1,140,800 ($992,000 * 1.15).
The New Net Operating Income will be:

New Net Operating Income = $1,140,800 – ($595,200 * 1.15) - $318,800
New Net Operating Income = $1,140,800 - $684,480 - $318,800
New Net Operating Income = $137,520

Margin = Net operating Income / Sales * 100
Margin = 137,520 / 1,140,800 * 100
Margin = 12.05% (Increase)

Turnover Ratio = Sales / Average Operating Assets
Turnover Ratio = 1,140,800 / 495,000
Turnover Ratio = 2.30 (Increase)

ROI = Margin * Turnover Ratio
ROI = 12.05 * 2.30
ROI = 27.72% (Increase)

Answer to Requirement No. 6:

Written off Obsolete inventory worth $16,000 will reduce Net Operating Assets by $16,000. The New Average Operating Assets will be $479,000 ($495,000 - $16,000).

Margin = Net operating Income / Sales * 100
Margin = 78,000 / 992,000 * 100
Margin = 7.86% (No Effect)

Turnover Ratio = Sales / Average Operating Assets
Turnover Ratio = 992,000 / 479,000
Turnover Ratio = 2.07 (Increase)

ROI = Margin * Turnover Ratio
ROI = 7.86 * 2.07
ROI = 16.27% (Increase)

Answer to Requirement No. 7:

The use of cash to repurchase and retire Common Stock will reduce the Average Operating Assets by $182,000. Therefore, the New Average Operating Assets will be $313,000 ($495,000 - $182,000).

Margin = Net operating Income / Sales * 100
Margin = 78,000 / 992,000 * 100
Margin = 7.86% (No Effect)

Turnover Ratio = Sales / Average Operating Assets
Turnover Ratio = 992,000 / 313,000
Turnover Ratio = 3.17 (Increase)

ROI = Margin * Turnover Ratio
ROI = 7.86 * 3.17
ROI = 24.92% (Increase)

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