Reference no: EM132687352
Problem - Effect of proposals on divisional performance - A condensed income statement for the Electronics Division of Fannie Industries Inc. for the year ended January 31, 2012, is as follows:
Sales $870,000
Cost of goods sold 455,600
Gross profit $414,400
Operating expenses 310,000
Income from operations $104,400
Invested assets $696,000
Assume that the Electronics Division received no charges from service departments.
The president of Fannie Industries Inc. has indicated that the division's rate of return on a $696,000 investment must be increased to at least 20% 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 $96,000 to other divisions at no gain or loss and lease similar equipment. The annual lease payments would be less than the amount of depreciation expense on the old equipment by $34,800. This decrease in expense would be included as part of the cost of goods sold. Sales would remain unchanged.
Proposal 2: Reduce invested assets by discontinuing a product line. This action would eliminate sales of $100,000, cost of goods sold of $42,600, and operating expenses of $30,000. Assets of $146,000 would be transferred to other divisions at no gain or loss.
Proposal 3: Purchase new and more efficient machinery and thereby reduce the cost of goods sold by $87,000. Sales would remain unchanged, and the old machinery, which has no remaining book value, would be scrapped at no gain or loss. The new machinery would increase invested assets by $754,000 for the year.
Instructions -
1. Using the DuPont formula for rate of return on investment, determine the profit margin, investment turnover, and rate of return on investment for the Electronics Division for the past year. Round investment turnover to two decimal places.
2. Prepare condensed estimated income statements and compute the invested assets for each proposal.
3. 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.
4. Which of the three proposals would meet the required 20% rate of return on investment?
5. If the Electronics 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 president's required 20% rate of return on investment? Round to one decimal place.