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Ratio Calculation for Northern Division of Loring Company

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13-4
The following data have been collected for the past two years for the Northern Division of Loring Company:

2005 2006
Sales \$50,000,000 \$50,000,000
Operating Income 4,500,000 4,100,000
Average Operating Assets 25,000,000 25,000,000

REQUIRED:
1. COMPUTE THE MARGIN AND TURNOVER RATIOS FOR EACH YEAR.
2. COMPUTE THE ROI FOR EACH YEAR.
3. EXPLAIN WHY THE DIVISION EXPERIENCED A DECREASED A ROI FROM 2005 TO 2006.

13-6
CHERYL MANNERS, DIVISION MANAGER OF RADIOTECH, INC., WAS DEBATING THE MERITS OF A NEW PRODUCT-A WEATHER RADIO THAT WOULD PUT OUT A WARNING IF THE COUNTY IN WHICH THE LISTENER LIVED WAS UNDER A SEVERE THUNDERSTORM OR TORNADO ALERT. THE BUDGETED INCOME OF THE DIVISION WAS \$480,000 WITH OPERATING ASSETS OF \$8,000,000. THE PROPOSED INVESTMENT WOULD ADD INCOME OF \$270,000 AND WOULD REQUIRE AN ADDITIONAL INVESTMENT IN EQUIPMENT OF \$1,500,000.

REQUIRED
1. COMPUTE THE ROI OF:
A. THE DIVISION IF THE RADIO PROJECT IS NOT UNDERTAKEN
C. THE DIVISION IF THE RADIO PROJECT IS UNDERTAKEN

2. DO YOU SUPPOSE THAT CHERYL WILL DECIDE TO INVEST IN THE NEW RADIO? WHY OR WHY NOT?

16-2
SUPPOSE THAT THE ADAMS COMPANY SELLS A PRODUCT FOR \$16. UNIT COSTS ARE AS FOLLOWS:

DIRECT MATERIALS \$3.90
DIRECT LABOR \$1.40
VARIABLE SELLING EXPENSES \$1.60
TOTAL FIXED OVERHEAD IS \$52,000 PER YEAR, AND TOTAL FIXED SELLING AND ADMINISTRATIVE EXPENSES ARE \$37,950. NORMAL PRODUCTION IS 13,000 UNITS PER YEAR.
REQUIRED:
MATCH A TERM FROM COLUMN A WITH THE CORRECT NUMBER BASED ON THE ABOVE INFORMATION FOR ADAMS COMPANY IN COLUMN B.

# COLUMN A COLUMN B
1 CONTRIBUTION MARGIN A. 12,850
2 CONTRIBUTION MARGIN RATIO B. 0.5625
3 VARIABLE COST RATIO C. \$9.00
4 BREAK-EVEN UNITS D. 0.4375
5 PRIME COST PER UNIT E. \$7.50
6 CONVERSION COST PER UNIT F. \$7.00
7 VARIABLE COST PER UNIT G. \$5.30
16-4
THE CONTROLLER OF KERRISK COMPANY PREPARED THE FOLLOWING PROJECTED INCOME STATEMENT:
SALES (5,000 UNITS @ \$15) \$75,000
LESS: VARIABLE COSTS 60,000
CONTRIBUTION MARGIN 15,000
LESS: FIXED COSTS 10,350
OPERATING INCOME 4,650

REQUIRED:
1. WHAT IS THE CONTRIBUTION MARGIN PER UNIT FOR KERRISK COMPANY? WHAT IS THE CONTRIBUTION MARGIN RATIO?
2. WHAT IS THE VARIABLE COST RATIO FOR KERRISK COMPANY?
3. CALCULATE THE BREAK- EVEN REVENUE.
4. HOW MUCH REVENUE MUST KERRISK MAKE TO ERAN OPERATING INCOME EQUAL TO \$9,900?

17-7
SHERWOOD COMPANY IS CURRENTLY MANUFACTURING PART Z911, PRODUCING 40,000 UNITS ANNUALLY. The part is used in the procution of several products made by Sherwood. The cost per unit for z911 is as follows:

DIRECT MATERIALS \$9.00
DIRECT LABOR 3.00
TOTAL \$18.50

OF THE TOTAL FIXED OVERHEAD ASSIGNED TO Z911, \$88,000 IS DIRECT FIXED OVERHEAD (THE LEASE OF PRODUCTION MACHINERY AND SALARY OF A PRODUCTION LINE SUPERVISOR- NIETHER OF WHICH WILL BE NEEDED IF THE LINE IS DROPPED). THE REMAINING FIXED OVERHEAD IS COMMON FIXED OVERHEAD. AN OUTISDE SUPPLIER HAS OFFERED TO SELL THE PART TO SHEWOOD FOR \$16. THERE IS NO ALTERNATIVE USE FOR THE FACILITIES CURRENTLY USED TO PRODUCE THE PART.
REQUIRED:
1. SHOULD SHERWOOD COMPANY MAKE OR BUY PART Z911?
2. WHAT IS THE MOST SHERWOOD WOULD BE WILLING TO PAY AN OUTSIDE SUPPLIER?
3. IF SHERWOOD BOUGHT THE PART, BY HOW MUCH WOULD INCOME INCREASE OR DECREASE?

18-2
EACH OF THE FOLLOWING PARTS IS INDEPENDENT. ASSUME ALL CASH FLOWS ARE AFTER-TAX CASH FLOWS.
1. KAYLIN DAY HAS JUST INVESTED \$480,000 IN A BOOK AND VIDEO STORE. SHE EXPECTS TO RECEIVE AN INCOME OF \$144,000 PER YEAR FROM THE INVESTMENT. WHAT IS THE PAY-BACK PERIOD FOR KAYLIN?
2. JAN BOOTH PLACED \$128,000 IN A 3 YR SAVINGS PLAN. THE PLAN PAYS 5 PERCENT, AND SHE CANNOT WITHDRAW THE MONEY EARLY WITHOUT A PENALTY. ASSUMING THAT JAN LEAVES THE MONEY IN THE PLAN FOR THE FULL THREE YEARS, HOW MUCH MONEY WILL SHE HAVE?
3. COLBY HEPWORTH, MANAGER OF THE FEDER CREDIT UNION, IS CONSIDERING THE PURCHASE OF A NEW AUTOMATED TELLER SYSTEM. THE CASH BENEFITS WILL BE \$208,000 PER YEAR. THE SYSTEM COSTS \$1,088,000 AND WILL LAST TEN YEARS. COMPUTE THE NPV SUMING A DISCOUNT RATE OF 12 PERCENT. SHOULD THE BANK BUY THE NEW TELLER SYSTEM?
4. EMILY HANSEN HAS JUST INVESTED \$200,000 IN A COMPANY. SHE EXPECTS TO RECEIVE \$32,200 PER YEAR FOR THE NEXT EIGHT YEARS. HER COST OF CAPITAL IS 6 PERCENT. COMPUTE THE INTERNAL RATE OF RETURN. DID EMILY MAKE A GOOD DECISION?

Solution Preview

13-4
The following data have been collected for the past two years for the Northern Division of Loring Company:

2005 2006
Sales \$50,000,000 \$50,000,000
Operating Income 4,500,000 4,100,000
Average Operating Assets 25,000,000 25,000,000

REQUIRED:
1. COMPUTE THE MARGIN AND TURNOVER RATIOS FOR EACH YEAR.
The margin is calculated as Operating Income/Sales and the turnover ratio is Sales/Average Operating Assets
2005 2006
Margin 9% 8.2%
Turnover 2 2

2. COMPUTE THE ROI FOR EACH YEAR.

The Return on Investment (ROI) is calculated as Net Income/Average Operating Assets.
ROI = Operating Income/Sales X Sales/Average Operating Assets
ROI = Margin X Turnover
2005 2006
ROI 18% 16.4%
3. EXPLAIN WHY THE DIVISION EXPERIENCED A DECREASED A ROI FROM 2005 TO 2006.

The ROI decreased due the reduction in operating income. The operating assets and sales were constant. The reduced operating income reduced the margin, which with a constant turnover reduced the ROI.

13-6
CHERYL MANNERS, DIVISION MANAGER OF RADIOTECH, INC., WAS DEBATING THE MERITS OF A NEW PRODUCT-A WEATHER RADIO THAT WOULD PUT OUT A WARNING IF THE COUNTY IN WHICH THE LISTENER LIVED WAS UNDER A SEVERE THUNDERSTORM OR TORNADO ALERT. THE BUDGETED INCOME OF THE DIVISION WAS \$480,000 WITH OPERATING ASSETS OF \$8,000,000. THE PROPOSED INVESTMENT WOULD ADD INCOME OF \$270,000 AND WOULD REQUIRE AN ADDITIONAL INVESTMENT IN EQUIPMENT OF \$1,500,000.

REQUIRED
1. COMPUTE THE ROI OF:
A. THE DIVISION IF THE RADIO PROJECT IS NOT UNDERTAKEN
ROI = Net Income/Operating Assets
If the radio project is not undertaken, then the budgeted income would be 480,000 and the operating assets would be 8,000,000.
The ROI is 480,000/8,000,000 = 6%

The radio project alone has an income of 270,000 and requires assets of 1,500,000 ( the investment would be in the assets).
The ROI = 270,000/1,500,000 = 18%

C. THE DIVISION IF THE RADIO PROJECT IS UNDERTAKEN

If the radio project is undertaken, the income of the division would increase to 480,000+270,000=750,000
The assets would increase to 8,000,000+1,500,000=9,500,000
The ROI=750,000/9,500,000 = 7.89%

2. DO YOU SUPPOSE THAT CHERYL WILL DECIDE TO INVEST IN THE NEW RADIO? WHY OR WHY NOT?

It will decide to invest in the new radio. The ROI is much higher than the existing ROI and if the project is included, then the ROI of the division also increases from 6% to 7.89%.

16-2
SUPPOSE THAT THE ADAMS COMPANY SELLS A PRODUCT FOR \$16. UNIT COSTS ARE AS FOLLOWS:

DIRECT MATERIALS \$3.90
DIRECT LABOR \$1.40