Chapter 10, Problem 1CE

Forchen, Inc., provided the following information for two of its divisions for last year:

Required:

1. 1. For the Small Appliances Division, calculate:
   1. a. Average operating assets
   2. b. Margin
   3. c. Turnover
   4. d. Return on investment (ROI)
2. 2. For the Cleaning Products Division, calculate:
   1. a. Average operating assets
   2. b. Margin
   3. c. Turnover
   4. d. Return on investment (ROI)
3. 3. What if operating income for the Small Appliances Division was $2,000,000? How would that affect average operating assets? Margin? Turnover? ROI? Calculate any changed ratios (round to four significant digits).

To determine

Calculate the average operating assets for Division A.

Explanation of Solution

Operating assets: Operating assets are the assets which includes all the assets used to generate the operating income. Average operating assets are the average of beginning and ending operating assets.

$\text{Average operating assets = }\left(\text{Beginning operating assets + Ending operating assets}\right)/2$

Calculate the average operating assets for Division A:

$\begin{array}{c}\text{Average operating assets = }\left(\text{Beginning operating assets + Ending operating assets}\right)/2\\ =\left(\$6,394,000+\$7,474,000\right)/2\\ =\left(\$13,868,000\right)/2\\ =\$6,934,000\end{array}$

Therefore, the average operating assets for Division A are $6,934,000.

To determine

Compute the Margin for the Division A.

Explanation of Solution

Margin: It is an amount income generated by a dollar of sales. It is calculated as follows:

$\text{Margin}\text{=}\frac{\text{Operating Income}}{\text{Sales}}$

Compute the margin for Division A:

$\begin{array}{c}\text{Margin}\text{=}\frac{\text{Operating Income}}{\text{Sales}}\\ =\frac{\$2,773,600}{\$34,670,000}\\ =0.08\text{or 8\%}\end{array}$

Therefore, margin of Division A is 8%.

To determine

Compute the turnover of Division A.

Explanation of Solution

Turnover: It is an amount of sales generate by average operating assets. It is calculated by dividing the sales by the average operating assets in the assets, required to generate those sales.

$\text{Turnover = }\frac{\text{Sales}}{\text{Average Operating Assets}}$

Compute the turnover of Division A:

$\begin{array}{c}\text{Turnover = }\frac{\text{Sales}}{\text{Average Operating Assets}}\\ =\frac{\$34,670,000}{\$6,934,000}\\ =5.0\text{times}\end{array}$

Therefore, turnover of Division A is 5.0 times of average operating assets.

To determine

Compute the ROI of Division A.

Explanation of Solution

Return on investment (ROI): This financial ratio evaluates how efficiently the assets are used in earning income from operations. So, ROI is a tool used to measure and compare the performance of a units or divisions or a companies.

$\text{ROI = Margin}\times \text{Turnover}$

Compute the ROI of Division A:

$\begin{array}{c}\text{ROI = Margin}\times \text{Turnover}\\ \text{=}\text{0}\text{.08}\times \text{5}\text{.0}\\ \text{=}\text{0}\text{.40}\text{or 40\%}\end{array}$

Therefore, ROI of Division A is 40%.

To determine

Calculate the average operating assets for Division P.

Explanation of Solution

Calculate the average operating assets for Division P:

$\begin{array}{c}\text{Average operating assets = }\left(\text{Beginning operating assets + Ending operating assets}\right)/2\\ =\left(\$5,600,000+\$6,000,000\right)/2\\ =\left(\$11,600,000\right)/2\\ =\$5,800,000\end{array}$

Therefore, the average operating assets for Division P are $5,800,000.

To determine

Compute the Margin for the Division P.

Explanation of Solution

Compute the margin for Division P:

$\begin{array}{c}\text{Margin}\text{=}\frac{\text{Operating Income}}{\text{Sales}}\\ =\frac{\$1,252,800}{\$31,320,000}\\ =0.04\text{or 4\%}\end{array}$

Therefore, margin of Division P is 4%.

To determine

Compute the turnover of Division P.

Explanation of Solution

Compute the turnover of Division P:

$\begin{array}{c}\text{Turnover = }\frac{\text{Sales}}{\text{Average Operating Assets}}\\ =\frac{\$31,320,000}{\$5,800,000}\\ =5.4\text{times}\end{array}$

Therefore, turnover of Division P is 5.4 times of average operating assets.

To determine

Compute the ROI of Division P.

Explanation of Solution

Compute the ROI of Division A:

$\begin{array}{c}\text{ROI = Margin}\times \text{Turnover}\\ \text{=}\text{0}\text{.04}\times \text{5}\text{.4}\\ \text{=}\text{0}\text{.216}\text{or 21}\text{.6\%}\end{array}$

Therefore, ROI of Division P is 21.6%.

To determine

Explain the effect of change in operating income on average operating assets, margin, turnover, and ROI of Division A. Compute the new ratios if any.

Explanation of Solution

In the given situation, the new operating income is lower. Thus, both margin and ROI would be lower. 

Average operating assets and turnover not affected by change in the operating income, since    operating income is not a part of the equations for them.

Calculate the new margin and ROI for Division A:

$\begin{array}{c}\text{Margin}\text{=}\frac{\text{Operating Income}}{\text{Sales}}\\ =\frac{\$2,000,000}{\$34,670,000}\\ =0.0577\text{or 5}\text{.77\%}\end{array}$

Therefore, new margin is 5.77%.

$\begin{array}{c}\text{ROI = Margin}\times \text{Turnover}\\ \text{=}\text{0}\text{.0577}\times \text{5}\text{.0}\\ \text{=}\text{0}\text{.2885}\text{or 28}\text{.85\%}\end{array}$

Therefore, new ROI is 28.85%.