Question

Commercial Services.com Corporation provides business-to-business services on the Internet. Data concerning the most recent year appear below:

Sales $3,000,000
Net operating income $150,000
Average operating assets $750,000
Required:
Consider each question below independently. Carry out all computations to two decimal places.
1. Compute the company’s return on investment (ROI).
2. The entrepreneur who founded the company is convinced that sales will increase next year by 50% and that net operating income will increase by 200%, with no increase in average operating assets. What would be the company's ROI?
3. The chief financial officer of the company believes a more realistic scenario would be a $1,000,000 increase in sales, requiring a $250.000 increase in average operating assets, with a resulting $200,000 increase in net operating income. What would be the company’s ROI in this scenario?

Answer 1

1. ROI = Margin * Turnover

Margin = Net operating income / Sales

= 150,000 / 3,000,000

= 5%

Turnover = Sales / Average operating assets

= 3,000,000 / 750,000

= 4 times

ROI = 5% * 4

= 20%

2. Sales will increase by 50% and NOI will increase by 200%.

Margin = (150,000 * (1 + 200%)) / (3,000,000 * ( 1 + 50%))

= 10%

Turnover = (3,000,000 * ( 1 + 50%)) / 750,000

= 6

ROI = 10% * 6

= 60%

3. Sales will increase by $1,000,000. Average operating assets by $250,000 and NOI will increase by $200,000

Margin = (150,000 + 200,000) / (3,000,000 + 1,000,000)

= 8.75%

Turnover = (3,000,000 + 1,000,000) / (750,000 + 250,000)

= 4

ROI = 8.75% * 4

= 35%