Mastery Problem: Return on Investment, margin, and turnover

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Return on Investment (ROI)

The manager of an investment center should be evaluated based on revenues, costs, and investments. An evaluation based on net income ignores the amount of investment the investment center required. One way to measure operating profit in relation to investment is a calculation called the return on investment.

One formula for calculating return on investment is:

Operating income Invested Assets

ROI is effective because it takes into consideration the three factors under the control of an investment center manager: revenues, costs, and investments. ROI measures the income (or return) earned on each dollar of investment.

APPLY THE CONCEPTS: Calculating return on investment

The divisional income statements for three divisions of the Wiston Company are shown.

Wiston Company
Divisional Income Statements
For the Year Ending December 31, 2012
	Division A			Division B			Division C
Sales Revenue	$868,600			$1,213,000			$283,500
Operating expenses	(512,474)			(909,750)			(150,255)
Operating income before service department charges	$356,126			$303,250			$133,245
Service department charges	(225,836)			(157,690)			(93,555)
Operating income	$130,290			$145,560			$39,690

Additional financial data from the three divisions of the Wiston Company are shown.

	Division A		Division B		Division C
Invested assets		$1,010,000		$606,500		$405,000

Calculate the return on investment for each division. If required, round the ROI to the nearest hundredth of a percent (for example, 16.943% would be rounded to 16.94%).

	Division A	Division B	Division C
Return on investment	fill in the blank bcf148ffbff5fee_1 %	fill in the blank bcf148ffbff5fee_2 %	fill in the blank bcf148ffbff5fee_3 %

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Margin and Turnover

One way to analyze the difference in return on investment for each division is to separate the return on investment formula into two calculations: margin and turnover. Margin shows the relationship between operating income and sales. It measures the profit earned for each dollar of sales, which is a measure of

operating profitabilityoperating efficiency

. Turnover shows the relationship between sales and invested assets. It measures how many dollars of sales result from each dollar of invested assets, which is a measure of

operating profitabilityoperating efficiency

.

The formulas for margin and turnover are:

Margin	=	Operating incomeInvested AssetsSales Operating incomeInvested AssetsSales
Turnover	=	Operating incomeInvested AssetsSales Operating incomeInvested AssetsSales

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APPLY THE CONCEPTS: Calculating margin and turnover

Calculate the margin and the turnover for each division. If required, round margin to the nearest tenth of a percent (for example, 14.6%) and turnover to two decimal places (for example, 0.82).

	Division A		Division B		Division C
Margin	fill in the blank 95fca6fa0042043_1	%	fill in the blank 95fca6fa0042043_2	%	fill in the blank 95fca6fa0042043_3	%
Turnover	fill in the blank 95fca6fa0042043_4		fill in the blank 95fca6fa0042043_5		fill in the blank 95fca6fa0042043_6

The division showing the highest operating profitability is Division

BAC

.

The division showing the highest operating efficiency is Division

ABC

.

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APPLY THE CONCEPTS: Using margin and turnover to calculate return on investment

A second way to calculate return on investment (ROI) is Return on Investment = Margin x Turnover. Using the margins and turnovers you recorded above, calculate the return on investment for each division. If required, round the return on investment to the nearest hundredth of a percent (for example, 16.94%).

	Division A	Division B	Division C
Return on investment	fill in the blank aae567012ffe017_1 %	fill in the blank aae567012ffe017_2 %	fill in the blank aae567012ffe017_3 %

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APPLY THE CONCEPTS: Determining which ROI formula to use

There are two formulas for calculating ROI:

1. ROI = Operating income / Invested Assets
2. ROI = Margin x Turnover

Why would a company use the second formula (ROI = Margin x Turnover) to calculate ROI? Select the YES or NO to the following statements.

a.	Margin can be tracked separately.	YesNo
b.	If ROI changes, managers can determine which factor caused overall ROI to change.	YesNo
c.	It is easier to calculate.	YesNo
d.	Turnover can be tracked separately.	YesNo
e.	Both formulas give exactly the same information, so there is no reason to use the second formula.	YesNo