Digital Company has net operating income of USD 500,000 and
operating assets of USD 2,000,000.
Its net sales are USD 4,000,000.
The accountant for the company computes the rate of return on operating assets after computing the operating margin and the turnover of operating assets.
a. Show the computations the accountant made.
b. Indicate whether the operating margin and turnover increase or decrease after each of the following changes. Then determine what the actual rate of return on operating assets would be. The events are not interrelated; consider each separately, starting from the original earning power position. No other changes occurred.
(a)Sales increased by USD 160,000. There was no change in the amount of operating income and no change in operating assets.
(b)Management found some cost savings in the manufacturing process. The amount of reduction in operating expenses was USD 40,000. The savings resulted from the use of less materials to manufacture the same quantity of goods. As a result, average inventory was USD 16,000 lower than it otherwise would have been. Operating income was not affected by the reduction in inventory.
(c)The company invested USD 80,000 of cash (received on accounts receivable) in a plot of land it plans to use in the future (a non-operating asset); income was not affected.
(d)The federal income tax rate increased and caused income tax expense to increase by USD 20,000. The taxes have not yet been paid.
(e)The company issued bonds and used the proceeds to buy USD 400,000 of machinery to be used in the business. Interest payments are USD 20,000 per year. Net operating income increased by USD 100,000 (net sales did not change).