(Evaluating performance, LO2) Nywening Ltd. (Nywening) operates in a highly competitive industry. Price is very important to most customers and it is very difficult for small operators such as Nywening to differentiate themselves on product quality. It is possible to differentiate based on service, but most competitors offer reasonably comparable service packages.

The president of Nywening is reviewing the company’s performance in 2005.

During 2005 sales increased by 12% to $3,500,000. Average total assets for the year were $1,950,000, net income was $200,000, and interest expense was $60,000.

Nywening’s tax rate is 20%.

The president believes that Nywening can improve its performance in 2006. She would like to see a 15% growth in sales in 2006 and a return on assets of 20%. The president estimates that it will be necessary to increase assets by 10% in 2006. The president does not think that any additional borrowing will be required and, as a result, the interest expense for 2006 will be the same as for 2005.
Required:

a. Calculate Nywening’s profit margin, asset turnover, and return on assets for 2005.

b. What asset turnover ratio is required in 2006 to achieve the president’s objectives? What net income is needed to achieve her objectives? What would the profit margin be if the objectives are achieved? For purposes of this question use net income plus the after tax cost of interest.

c. Do you think the president’s objectives are reasonable?