A company that is seeking to increase ROI should attempt to decrease:
a) sales.
b) turnover.
c) margin.
d) average operating assets.
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âI know headquarters wants us to add that new product line,â said Dell Havasi, manager of Billings Companyâs Office Products Division. âBut I want to see the numbers before I make any move. Our divisionâs return on investment (ROI) has led the company for three years, and I donât want any letdown.â |
Billings Company is a decentralized wholesaler with five autonomous divisions. The divisions are evaluated on the basis of ROI, with year-end bonuses given to the divisional managers who have the highest ROIs. Operating results for the companyâs Office Products Division for the most recent year are given below: |
Sales | $ | 21,810,000 |
Variable expenses | 13,741,200 | |
Contribution margin | 8,068,800 | |
Fixed expenses | 6,040,000 | |
Net operating income | $ | 2,028,800 |
Divisional operating assets | $ | 4,363,000 |
The company had an overall return on investment (ROI) of 18.00% last year (considering all divisions). The Office Products Division has an opportunity to add a new product line that would require an additional investment in operating assets of $2,350,000. The cost and revenue characteristics of the new product line per year would be: |
Sales | $ 9,396,500 |
Variable expenses | 65% of sales |
Fixed expenses | $ 2,564,875 |
Required: | ||||||||||
1. | Compute the Office Products Divisionâs ROI for the most recent year; also compute the ROI as it would appear if the new product line is added. (Round the "Margin", "Turnover" and "ROI" answers to 2 decimal places.) | |||||||||
Present | New Line | Total | ||||||||
Sales | ||||||||||
Net Operating Income | ||||||||||
Operating Assets | ||||||||||
Margin | % | % | % | |||||||
Turnover | ||||||||||
ROI | % | % | % | |||||||
2. | If you were in Dell Havasiâs position, would you accept or reject the new product line? | ||||
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3. | Why do you suppose headquarters is anxious for the Office Products Division to add the new product line? | ||||
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4. | Suppose that the companyâs minimum required rate of return on operating assets is 15.00% and that performance is evaluated using residual income. |
a. | Compute the Office Products Divisionâs residual income for the most recent year; also compute the residual income as it would appear if the new product line is added.
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b. | Under these circumstances, if you were in Dell Havasiâs position, would you accept or reject the new product line? | ||||
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Selected sales and operating data for three divisions of three different companies are given below: |
Division A | Division B | Division C | |||||||
Sales | $ | 6,900,000 | $ | 10,900,000 | $ | 10,000,000 | |||
Average operating assets | $ | 1,725,000 | $ | 5,450,000 | $ | 2,500,000 | |||
Net operating income | $ | 414,000 | $ | 1,090,000 | $ | 325,000 | |||
Minimum required rate of return | 19 | % | 20 | % | 16 | % | |||
Required: | |
1. | Compute the return on investment (ROI) for each division, using the formula stated in terms of margin and turnover. (Do not round intermediate calculations. Round your answers to 2 decimal places.) |
ROI | |
Division A | % |
Division B | % |
Division C | % |
2. | Compute the residual income for each division. (Negative amounts should be indicated by a minus sign. Leave no cells blank - be certain to enter "0" wherever required.) |
Division A | Division B | Division C | |
Residual income | $ | $ | $ |
Data for Barry Computer Co. and its industry averages follow.
Barry Computer Company: | ||||
Balance Sheet as of December 31, 2014 (In Thousands) | ||||
Cash | $139,080 | Accounts payable | $139,080 | |
Receivables | 382,470 | Other current liabilities | 115,900 | |
Inventories | 231,800 | Notes payable | 127,490 | |
Total current assets | $753,350 | Total current liabilities | $382,470 | |
Long-term debt | $266,570 | |||
Net fixed assets | 405,650 | Common equity | 509,960 | |
Total assets | $1,159,000 | Total liabilities and equity | $1,159,000 |
Barry Computer Company: Income Statement for Year Ended December 31, 2014 (In Thousands) | |||
Sales | $1,900,000 | ||
Cost of goods sold | |||
Materials | $779,000 | ||
Labor | 418,000 | ||
Heat, light, and power | 95,000 | ||
Indirect labor | 190,000 | ||
Depreciation | 57,000 | $1,539,000 |
Gross profit | $361,000 | |
Selling expenses | 228,000 | |
General and administrative expenses | 19,000 | |
Earnings before interest and taxes (EBIT) | $114,000 | |
Interest expense | 26,657 | |
Earnings before taxes (EBT) | 87,343 | |
Federal and state income taxes (40%) | 34,937 | |
Net income | $52,406 |
1. Calculate the indicated ratios for Barry. Round your answers to two decimal places.
Ratio | Barry | Industry Average |
Current | x | 1.99x |
Quick | x | 1.35x |
Days sales outstandinga | days | 34.99days |
Inventory turnover | x | 8.44x |
Total assets turnover | x | 1.91x |
Profit margin | % | 2.63% |
ROA | % | 5.02% |
ROE | % | 10.93% |
ROIC | % | 7.90% |
TIE | x | 3.20x |
Debt/Total capital | % | 47.00% |
aCalculation is based on a 365-day year.
2. Construct the Du Pont equation for both Barry and the industry. Round your answers to two decimal places.
FIRM | INDUSTRY | |
Profit margin | % | 2.63% |
Total assets turnover | x | 1.91x |
Equity multiplier |
3. Outline Barry's strengths and weaknesses as revealed by your analysis. Select One below
a. The firm's days sales outstanding is less than the industry average, indicating that the firm should tighten credit or enforce a more stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets decreased, or both. While the company's profit margin is lower than the industry average, its other profitability ratios are high compared to the industry - net income should be higher given the amount of equity and assets. However, the company seems to be in an average liquidity position and financial leverage is similar to others in the industry.
b. The firm's days sales outstanding is more than the industry average, indicating that the firm should tighten credit or enforce a more stringent collection policy. The total assets turnover ratio is well above the industry average so sales should be increased, assets increased, or both. While the company's profit margin is higher than the industry average, its other profitability ratios are low compared to the industry - net income should be higher given the amount of equity and assets. However, the company seems to be in an above average liquidity position and financial leverage is similar to others in the industry.
c. The firm's days sales outstanding is comparable to the industry average, indicating that the firm should neither tighten credit nor enforce a more stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets increased, or both. While the company's profit margin is higher than the industry average, its other profitability ratios are low compared to the industry - net income should be higher given the amount of equity and assets. However, the company seems to be in a below average liquidity position and financial leverage is similar to others in the industry.
d. The firm's days sales outstanding ratio is more than twice as long as the industry average, indicating that the firm should tighten credit or enforce a more stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets decreased, or both. While the company's profit margin is higher than the industry average, its other profitability ratios are low compared to the industry - net income should be higher given the amount of equity and assets. However, the company seems to be in an average liquidity position and financial leverage is similar to others in the industry.
e. The firm's days sales outstanding is more than twice as long as the industry average, indicating that the firm should loosen credit or apply a less stringent collection policy. The total assets turnover ratio is well below the industry average so sales should be increased, assets increased, or both. While the company's profit margin is higher than the industry average, its other profitability ratios are low compared to the industry - net income should be higher given the amount of equity and assets. However, the company seems to be in an average liquidity position and financial leverage is similar to others in the industry.
4. Suppose Barry had doubled its sales as well as its inventories, accounts receivable, and common equity during 2014. How would that information affect the validity of your ratio analysis? (Hint: Think about averages and the effects of rapid growth on ratios if averages are not used. No calculations are needed.)
Select one below
a. If 2014 represents a period of normal growth for the firm, ratios based on this year will be accurate and a comparison between them and industry averages will have substantial meaning. Potential investors who look only at 2014 ratios will be misled, and a return to supernormal conditions in 2013 could hurt the firm's stock price.
b. If 2014 represents a period of supernormal growth for the firm, ratios based on this year will be distorted and a comparison between them and industry averages will have substantial meaning. Potential investors who look only at 2014 ratios will be well informed, and a return to normal conditions in 2013 could hurt the firm's stock price.
c. If 2014 represents a period of supernormal growth for the firm, ratios based on this year will be distorted and a comparison between them and industry averages will have little meaning. Potential investors who look only at 2014 ratios will be misled, and a return to normal conditions in 2013 could hurt the firm's stock price.
d. If 2014 represents a period of supernormal growth for the firm, ratios based on this year will be accurate and a comparison between them and industry averages will have substantial meaning. Potential investors need only look at 2014 ratios to be well informed, and a return to normal conditions in 2013 could help the firm's stock price.
e. If 2014 represents a period of normal growth for the firm, ratios based on this year will be distorted and a comparison between them and industry averages will have little meaning. Potential investors who look only at 2014 ratios will be misled, and a continuation of normal conditions in 2013 could hurt the firm's stock price.