Mastery Problem: Return on Investment, margin, and turnover

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 Duvall Company are shown.

Duvall Company
Divisional Income Statements
For the Year Ending December 31, 2012
	Division A			Division B			Division C
Sales Revenue	$960,000			$900,000			$320,000
Operating expenses	(564,500)			(675,000)			(170,000)
Operating income before service department charges	$395,500			$225,000			$150,000
Service department charges	(275,500)			(135,000)			(70,000)
Operating income	$120,000			$90,000			$80,000

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

	Division A		Division B		Division C
Invested assets		$1,000,000		$600,000		$400,000

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	%	%	%

Feedback

Divide Operating income by Invested Assets and express it as a percentage, rounded to to two decimal places.

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 profitability . 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 efficiency .

The formulas for margin and turnover are:

Margin	=	Operating income Sales
Turnover	=	Sales Invested Assets

Feedback

The Margin is a measure of income per sales dollar.

Turnover is a measure of sales dollars per asset dollar.

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		%		%		%
Turnover

The division showing the highest operating profitability is Division C .

The division showing the highest operating efficiency is Division B .

Feedback

For Margin, divide Operating income by Sales Revenue and express it as a percentage, rounded to one decimal place.

For Turnover, divide Sales Revenue by Invested Assets and round to two decimal places (this is NOT a percentage).

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	%	%	%