Question

The Morton Divison, an investment center of Bates Manufacturing Company, reported the following data for the current year.

Sales $3,000,000
Variable costs 1,800,000
Controllable fixed costs 200,000
Noncontrollabl fixed costs 300,000
Average operating assets 5,000,000
Top management is unhappy with the center's return on investment. The manager of Morton Division believes ROI can be improved by the following independed alternatives:
1. Increasae sales by 10% with no change in the contribution margin ratio
2. Reduce controllable and noncontrollable fixed costs 25% each
3. Reduce average operating assets by 20%
INSTRUCTIONS: (A) Compute the return on investment for the current year (B) Compute ROI under each alternative

Answer 1

The current ROI of Morton Division is 14%. An increase in sales by 10% would lead to an ROI of 15%, reducing fixed costs by 25% would result in an ROI of 16.5%, and reducing operating assets by 20% would yield an ROI of 17.5%.

Step-by-step explanation:

To compute the return on investment (ROI) of Morton Division of Bates Manufacturing Company for the current year, we need to subtract total costs (variable costs plus fixed costs) from sales and then divide by average operating assets:

ROI = (Sales - Variable costs - Controllable fixed costs - Noncontrollable fixed costs) / Average operating assets

For the current year, the ROI calculation would be as follows:

ROI = ($3,000,000 - $1,800,000 - $200,000 - $300,000) / $5,000,000
ROI = ($700,000) / $5,000,000
ROI = 0.14 or 14%

Next, we'll compute ROI under each alternative:

1. Increase sales by 10%:

New Sales = $3,000,000 * 1.1 = $3,300,000
New ROI = ($3,300,000 - $1,800,000 - $200,000 - $300,000) / $5,000,000 = 0.15 or 15%

2. Reduce controllable and noncontrollable fixed costs by 25% each:

New Controllable Fixed Costs = $200,000 * 0.75 = $150,000
New Noncontrollable Fixed Costs = $300,000 * 0.75 = $225,000
New ROI = ($3,000,000 - $1,800,000 - $150,000 - $225,000) / $5,000,000 = 0.165 or 16.5%

3. Reduce average operating assets by 20%:

New Average Operating Assets = $5,000,000 * 0.8 = $4,000,000
New ROI = ($3,000,000 - $1,800,000 - $200,000 - $300,000) / $4,000,000 = 0.175 or 17.5%