Knitpix Products is a division of Parker Textiles Inc During

Knitpix Products is a division of Parker Textiles Inc. During the coming year, it expects to earn income of $320,000 based on sales of $3.45 million Without any new investments, the division will have average operating assets of $3 million. The division is considering a capital investment project- adding knitting machines to produce gaiters-that requires an additional investment of $650,000 and increases net income by $57,500 (sales would increase by $575,000). If made, the investment would increase beginning operating assets by $650,000 and ending operating assets by $410,000. Assume that the actual cost of capital for the company is 9%. Required: 1. Compute the ROI for the division without the investment. Round your answer to two decimal places. 2. Compute the margin and turnover ratios without the investment. Show that the product of the margin and turnover ratios equals the ROI computed in Requirement 1. Round your answers to two decimal places. Margin Turnover ROI 3. Conceptual Connection: Compute the ROI for the division with the new investment. Round your answer to one decimal place. Do you think the divisional manager will approve the investment? 4. Conceptual Connection: Compute the margin and turnover ratios for the division with the new investment. Round your answers to two decimal places. How do these compare with the old ratios?

Solution

Answer to Question 1.

Return on Investment (ROI) = Net Income / Average Operating Assets * 100
Return on Investment (ROI) = 320,000/ 3,000,000 * 100
Return on Investment (ROI) = 10.67%

Answer to Question 2.

Margin = Net Income / Sales * 100
Margin = 320,000 / 3,450,000 * 100
Margin = 9.28%

Turnover = Sales / Average Operating Assets
Turnover = 3,450,000 / 3,000,000
Turnover = 1.15

ROI = Margin * Turnover
Return on Investment (ROI) = 9.28%* 1.15
Return on Investment (ROI) = 10.67%

Answer to Question 3.

Return on Investment (ROI) = Net Income / Average Operating Assets * 100
Expected Net Income = $320,000 + $57,500
Expected Net Income = $377,500

Expected Average Operating Assets = $3,000,000 + ($650,000 + $410,000) / 2
Expected Average Operating Assets = $3,530,000

Return on Investment (ROI) = 377,500 / 3,530,000 * 100
Return on Investment (ROI) = 10.69%

Answer to Question 4.

Expected Sales = $3,450,000 + $575,000 = $4,025,000

Margin = Net Income / Sales * 100
Margin = 377,500 / 4,025,000 * 100
Margin = 9.38%

Turnover = Sales / Average Operating Assets
Turnover = 4,025,000 / 3,530,000
Turnover = 1.14

ROI = Margin * Turnover
Return on Investment (ROI) = 9.38%* 1.14
Return on Investment (ROI) = 10.69%