Mastery Problem: Return on Investment, margin, and turnover Question Content Area Return on Investment (ROI) The manager
Question:
Mastery Problem: Return on Investment, margin, and turnover
Question Content Area
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: |
|
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 Chung Company are shown.
| Chung Company | |||||||||
| Divisional Income Statements | |||||||||
| For the Year Ending December 31, 20Y8 | |||||||||
| Division A | Division B | Division C | |||||||
| Sales Revenue | $2,550,000 | $1,409,900 | $697,000 | ||||||
| Operating expenses | (1,504,500) | (1,057,425) | (369,410) | ||||||
| Operating income before service department charges | $1,045,500 | $352,475 | $327,590 | ||||||
| Service department charges | (586,500) | (211,485) | (243,950) | ||||||
| Operating income | $459,000 | $140,990 | $83,640 |
Additional financial data from the three divisions of the Chung Company are shown.
| Division A | Division B | Division C | ||||
| Invested assets | $1,020,000 | $613,000 | $410,000 |
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 93261f03906202c_1 % | fill in the blank 93261f03906202c_2 % | fill in the blank 93261f03906202c_3 % |
Question Content Area
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 | = |
| ||
| Turnover | = |
|
Question Content Area
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 3cf2c402b05d020_1 | % | fill in the blank 3cf2c402b05d020_2 | % | fill in the blank 3cf2c402b05d020_3 | % |
| Turnover | fill in the blank 3cf2c402b05d020_4 | fill in the blank 3cf2c402b05d020_5 | fill in the blank 3cf2c402b05d020_6 |
The division showing the highest operating profitability is Division
BAC
.
The division showing the highest operating efficiency is Division
BAC
.
Question Content Area
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 1a5bad023047f82_1 % | fill in the blank 1a5bad023047f82_2 % | fill in the blank 1a5bad023047f82_3 % |
Question Content Area
APPLY THE CONCEPTS: Determining which ROI formula to use
There are two formulas for calculating ROI:
- ROI = Operating income / Invested Assets
- 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. |
Expert Answer:
