Chapter 24, Problem 24.4CP

(1)

To determine

Profit margin: This ratio gauges the operating profitability by quantifying the amount of income earned from business operations from the sales generated.

Formula of profit margin:

$\text{Profit margin}=\frac{\text{Income from operations}}{\text{Sales}}$

To compute: Profit margin of N Division for the years 2014 to 2016

Explanation of Solution

Determine profit margin of N Division for the year 2014.

$\begin{array}{c}\text{Profit margin =}\frac{\text{Income from operations}}{\text{Sales}}\\ =\frac{\$220,500}{\$1,470,000}\\ \text{= }15\%\end{array}$

Determine profit margin of N Division for the year 2015.

$\begin{array}{c}\text{Profit margin =}\frac{\text{Income from operations}}{\text{Sales}}\\ =\frac{\$378,000}{\$2,100,000}\\ \text{= }18\%\end{array}$

Determine profit margin of N Division for the year 2016.

$\begin{array}{c}\text{Profit margin}\text{=}\frac{\text{Income from operations}}{\text{Sales}}\\ =\frac{\$539,000}{\$2,450,000}\\ \text{=}22\%\end{array}$

(2)

To determine

Investment turnover: This ratio gauges the operating efficiency by quantifying the amount of sales generated from the assets invested.

Formula of investment turnover:

$\text{Investment turnover}=\frac{\text{Sales}}{\text{Invested assets}}$

To compute: Investment turnover of N Division for the years 2014 to 2016

Explanation of Solution

Determine investment turnover of N Division for the year 2014.

$\begin{array}{c}\text{Investment turnover}\text{=}\frac{\text{Sales}}{\text{Invested assets}}\\ =\frac{\$1,470,000}{\$735,000}\\ \text{= }2.0\end{array}$

Determine investment turnover of N Division for the year 2015.

$\begin{array}{c}\text{Investment turnover=}\frac{\text{Sales}}{\text{Invested assets}}\\ =\frac{\$2,100,000}{\$1,500,000}\\ \text{= }1.\text{4}\end{array}$

Determine investment turnover of N Division for the year 2016.

$\begin{array}{c}\text{Investment turnover=}\frac{\text{Sales}}{\text{Invested assets}}\\ =\frac{\$2,450,000}{\$3,500,000}\\ \text{= }0.7\end{array}$

(3)

To determine

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.

Formula of ROI:

$\text{Return on investment = }\frac{\text{Income from operations}}{\text{Invested assets}}$

To compute: Return on investment (ROI)of N Divisionfor the years 2014 to 2016

Explanation of Solution

Determine ROI of N Division for the year 2014.

$\begin{array}{c}\text{Return on investment = }\frac{\text{Income from operations}}{\text{Invested assets}}\\ =\frac{\$220,500}{\$735,000}\\ \text{= 30\%}\end{array}$

Determine ROI of N Division for the year 2015.

$\begin{array}{c}\text{Return on investment =}\frac{\text{Income from operations}}{\text{Invested assets}}\\ =\frac{\$378,000}{\$1,500,000}\\ \text{= 25}\text{.2\%}\end{array}$

Determine ROI of N Division for the year 2016.

$\begin{array}{c}\text{Return on investment = }\frac{\text{Income from operations}}{\text{Invested assets}}\\ =\frac{\$539,000}{\$3,500,000}\\ \text{= 15}\text{.4\%}\end{array}$

(4)

To determine

To evaluate: Division N’s performance

Explanation of Solution

Evaluation of N Division’s performance:

By observing the operating results of N Division, the gross profit, income from operations, and revenues, it can be concluded that the performance of the division has increased considerably from 2014 to 2016. To know the actual performance, RPOI is computed in an extended form by using the profit margin, investment turnover as follows:

For 2014:

$\begin{array}{c}\text{Return on investment = Profit margin × Investment turnover}\\ \text{=}\frac{\text{Income from operations}}{\text{Sales}}\times \frac{\text{Sales}}{\text{Invested assets}}\\ =\frac{\$220,500}{\$1,470,000}\times \frac{\$1,470,000}{\$735,000}\\ \text{= }15\%\times 2.0\\ \text{= 30\%}\end{array}$

For 2015:

$\begin{array}{c}\text{Return on investment = Profit margin × Investment turnover}\\ \text{=}\frac{\text{Income from operations}}{\text{Sales}}\times \frac{\text{Sales}}{\text{Invested assets}}\\ =\frac{\$378,000}{\$2,100,000}\times \frac{\$2,100,000}{\$1,500,000}\\ \text{= }18\%\times 1.\text{4}\\ \text{= 25}\text{.2\%}\end{array}$

For 2016:

$\begin{array}{c}\text{Return on investment = Profit margin × Investment turnover}\\ \text{=}\frac{\text{Income from operations}}{\text{Sales}}\times \frac{\text{Sales}}{\text{Invested assets}}\\ =\frac{\$539,000}{\$2,450,000}\times \frac{\$2,450,000}{\$3,500,000}\\ \text{= }22\%\times 0.7\\ \text{= 15}\text{.4\%}\end{array}$

These computations show that the profitability of the division deteriorated from 2014 to 2016, due to the drop in investment turnover. So, the investments could not earn the required income, leading to decreased ROI. The assets invested were unable to earn the enough revenue.

This is a decreasing trend in the division’s performance.