PR 8-4A effect of proposals on divisional performance ObJ. 4

A condensed income statement for the Commercial Division of Maxell Manufacturing Inc.

Sales	$3,500,000
Cost of goods sold	2,480,000
Gross profit	$1,020,000
Operating expenses	600,000
Income from operations	$ 420,000
Invested assets	$2,500,000

for the year ended December 31, 2014, is as follows:

Assume that the Commercial Division received no charges from service departments. The president of Maxell Manufacturing has indicated that the divisions rate of return on a $2,500,000 investment must be increased to at least 21% by the end of the next year if operations are to continue. The division manager is considering the following three proposals:

Proposal 1: Transfer equipment with a book value of $312,500 to other divisions at no gain or loss and lease similar equipment. The annual lease payments would exceed the amount of depreciation expense on the old equipment by $105,000. This increase in expense would be included as part of the cost of goods sold. Sales would remain unchanged.

Proposal 2: Purchase new and more efficient machining equipment and thereby reduce the cost of goods sold by $560,000. Sales would remain unchanged, and the old equipment, which has no remaining book value, would be scrapped at no gain or loss. The new equipment would increase invested assets by an additional $1,875,000 for the year. Proposal 3: Reduce invested assets by discontinuing a product line. This action would eliminate sales of $595,000, reduce cost of goods sold by $406,700, and reduce operating expenses by $175,000. Assets of $1,338,000 would be transferred to other divisions at no gain or loss. instructions

Using the DuPont formula for rate of return on investment, determine the profit margin, investment turnover, and rate of return on investment for the Commercial Division for the past year.

Prepare condensed estimated income statements and compute the invested assets for each proposal.

Using the DuPont formula for rate of return on investment, determine the profit margin, investment turnover, and rate of return on investment for each proposal.

Which of the three proposals would meet the required 21% rate of return on investment?

If the Commercial Division were in an industry where the profit margin could not be increased, how much would the investment turnover have to increase to meet the presidents required 21% rate of return on investment? Round to one decimal place.

Rate of Return (ROI) on Investment

=

Profit Margin x Investment Turnover

Rate of Return (ROI) on Investment

=

Income from Operations

x

Sales

Sales

Invested Assets

Commercial Division:

ROI

=

x

=

MAXELL MANUFACTURING INC.COMMERICAL DIVISION

Estimated Income Statements

For the Year Ended December 31, 2014

Proposal 1

Proposal 2

Proposal 3

Sales

Cost of goods sold

Gross profit

Operating expenses

Income from operations

Invested assets

Rate of Return (ROI) on Investment

=

Profit Margin x Investment Turnover

Rate of Return (ROI) on Investment

=

Income from Operations

x

Sales

Sales

Invested Assets

Proposal 1:

ROI

=

x

=

Proposal 2:

ROI

=

x

=

Proposal 3:

ROI

=

x

=

Proposals 2 & 3

meet(s) the required 21% rate of return on investment.

Rate of return on investment (ROI)

=

Profit margin

x

Required investment turnover

=

x

Required investment turnover

Required investment turnover

=

Current investment turnover

=

Increase in investment turnover

=