Analysis of Operating Activities ♦ 501
5. Information is provided below for Travis Corp.
(in thousands)
2008
2007
Operating revenues
$2,400
$2,000
Cost of goods sold
1,500
1,500
Operating expenses
300
240
Net income
360
150
Total assets
4,000
3,000
Required:
a.
Compute profit margin, gross profit margin, operating profit margin, asset turnover,
and return on assets for each year rounded to three decimal places.
b.
Compare the company’s performance during the two years.
6. Virginia needs some accounting data for an upcoming meeting. The firm’s computer system is
down and is not expected to be running anytime soon. Virginia has compiled the following
information from various reports:
1.30 times
20%
3.4 times
8.0 times
$450,000
$250,000
Required:
Use the above information to compute the following:
a.
Operating revenues
b.
Net income
c.
Profit margin
d.
Accounts receivable
e.
Return on equity
Profit margin
(150/2,000) = 0.075
Gross profit margin
Operating profit margin
(260/2,000) = 0.130
Asset turnover
Return on assets
(150/3,000) = 0.050
502 ♦ Chapter 14
7. Information is provided below for two companies:
(in thousands)
Marisa
Sergio
Sales
$40,000
$168,000
Net income
1,200
3,860
Total assets
10,000
24,000
Required:
a.
Compute asset turnover, profit margin, and return on assets for each company.
b.
Compare the companies’ performance.
Asset turnover
Profit margin
Return on assets
b.
Sergio has a lower profit margin, but a much higher asset turnover. That results in a
8. Colonnade Enterprises has a profit margin of 10% and an asset turnover of 2.5 times. Operating
revenues totaled $600,000.
Required:
a.
Compute return on assets.
b.
Compute total assets.
c.
Compute net income.
d.
Based on the above information, what operating strategy is probably used by
Colonnade Enterprises?
Operating revenues = 1.30 × 450,000 = $585,000
b.
Net income = 20% × 450,000 = $90,000
Profit margin = 90,000 ÷ 585,000 = 15.38%
d.
Accounts receivable = $585,000 ÷ 8.0 = $73,125
e.
Return on equity = 20% × (450,000/200,000) = 45%
Analysis of Operating Activities ♦ 503
9. Information is provided below for two companies:
(in thousands)
Johnson
Lyndon
Sales
$14,000
$45,000
Net income
600
2,700
Total stockholders’ equity
5,600
9,000
Total assets
7,000
10,000
Required:
a.
Compute asset turnover, profit margin, return on assets, and return on equity for each
company.
b.
Compare the companies’ performance.
Asset turnover
Profit margin
Return on assets
Return on equity
b.
Lyndon has a slightly higher profit margin and a much higher asset turnover. That,
plus its apparent financial leverage, caused Lyndon to have a higher return on equity.
Return on assets = profit margin × asset turnover = 10% × 2.5 = 25%
b.
Total assets = operating revenues ÷ asset turnover = 600,000 ÷ 2.5 = 240,000
d.
Colonnade Enterprises appears to have a high asset turnover and a low profit margin
indicating a cost leadership operating strategy.
504 ♦ Chapter 14
10. Windpower Corporation’s management has decided to invest $8 million in production facilities
with the capacity to produce 800,000 units per year. Variable expenses will be $8 per unit. Fixed
expenses will be $2,400,000 per year. The firm has developed two sales scenarios for the coming
year:
a.
At a price of $12, below most of the competition, sales will be 700,000 units.
b.
At a price of $18, sales will be 400,000 units.
Required:
Develop a schedule showing profit from both scenarios. Which would you recommend? Why?
11. Information is presented below for two companies:
(in thousands)
Lashanna
Cambrell
Operating revenues
$4,500
$1,800
Net income
900
180
Total assets
6,000
1,200
Required:
a.
Compute profit margin, asset turnover, and return on assets for each firm.
b.
Compare the operating strategies of both firms and explain which is doing a better
job with its strategy.
Profit margin
Return on assets
Analysis of Operating Activities ♦ 505
12. Information is provided below for Cherokee Company:
(in thousands)
2008
2007
Operating revenues
$1,800
$1,600
Cost of goods sold
1,000
930
Operating expenses
270
210
Net income
310
270
Total assets
3,000
2,000
Required:
a.
Compute profit margin, gross profit margin, operating profit margin, asset turnover,
and return on assets for each year. Round to three decimal places.
b.
Compare the company’s performance during the two years.
13. Information is provided below for two companies:
(in thousands)
Clemens
Samuel
Sales
$36,000
$70,000
Net income
1,800
2,100
Total assets
12,000
20,000
Required:
a.
Compute asset turnover, profit margin, and return on assets for each company.
b.
Compare the companies’ performance.
Profit margin
(310/1,800) = 0.172
(270/1,600) = 0.169
Gross profit margin
Operating profit margin
(530/1,800) = 0.294
(460/1,600) = 0.288
Asset turnover
Return on assets
506 ♦ Chapter 14
14. Information is provided below for two companies:
(in thousands)
Ahura
Kirk
Sales
$18,000
$18,000
Net income
1,080
630
Total stockholders’ equity
7,200
4,850
Total assets
13,500
7,000
Required:
a.
Compute asset turnover, profit margin, return on assets, and return on equity for each
company.
b.
Compare the companies’ performances.
Asset turnover
Profit margin
Return on assets
Return on equity
a higher return on assets. Ahura, though, is apparently making better use of financial
Asset turnover
Profit margin
Return on assets
b.
Clemens has a higher profit margin and only a slightly lower asset turnover. That
Analysis of Operating Activities ♦ 507
15. Centronix Computers disclosed the following comparative information in its most recent annual
report.
2008
2007
Operating revenues
$240.0
$128.0
Operating income
23.1
26.2
Net income
19.2
21.7
Total assets
137.0
135.0
Required:
a.
Determine the asset turnover for each year.
b.
Determine the profit margin for each year.
c.
Determine the return on assets for each year.
d.
Comment on Centronix Computers’ effectiveness and efficiency over the 2-year period.
16. The following information is from the accounting systems of two local businesses:
Cyber Cafe
The Hideout
Operating revenues
$276,000
$149,000
Net income
124,000
42,000
Total assets
460,000
175,000
Required:
a.
Compute asset turnover, profit margin and return on assets for each firm.
b.
Based on your answers to part (a), describe the operating strategy for each firm.
a.
2008 operating revenues ÷ total assets = 240 ÷ 137 = 1.75 times
2007 operating revenues ÷ total assets = 128 ÷ 135 = 0.95 times
b.
2008 net income ÷ operating revenues = 19.2 ÷ 240 = 8%
2007 net income ÷ operating revenues = 21.7 ÷ 128 = 17%
c.
2008 asset turnover x profit margin = 1.75 × 8% = 14 %
2007 asset turnover x profit margin = .95 × 17% = 16.2%
caused the return on assets to decline from 16.2% to 14%.
508 ♦ Chapter 14
17. Microtech manufactures computer software. Its best selling product is WordJuggle. This product
has a profit margin of 15% and an asset turnover of 2.4 times. Operating revenues total $750,000.
Required:
a.
Compute return on assets.
b.
Compute total assets.
c.
Compute net income.
d.
Based on the above information, what operating strategy is probably used by
Microtech for this product?
a.
Return on assets = profit margin × asset turnover = 15% × 2.4 = 36%
b.
Total assets = operating revenues ÷ asset turnover =
$750,000 ÷ 2.4 = $312,500
Net income = operating revenues × profit margin =
$750,000 × .15 = $112,500
d.
Microtech appears to have a high asset turnover and a low profit margin, indicating
a cost leadership operating strategy for this product line.
Cyber Cafe:
asset turnover = operating revenues ÷ total assets = 276 ÷ 460 = .60 times
profit margin = net income ÷ operating revenues = 124 ÷ 276 = 45%
return on assets = asset turnover × profit margin = .60 × 45% = 27%
The Hideout
asset turnover = operating revenues ÷ total assets = 149 ÷ 175 = .85 times
profit margin = net income ÷ operating revenues = 42 ÷ 149 = 28%
return on assets = asset turnover × profit margin = .85 × 28% = 23.8%
Analysis of Operating Activities ♦ 509
18. Diamond Fixtures, Inc. is concerned about the continuing profitability of one of its product lines—
a shower massager. A new competitor has entered the market and Diamond Fixtures is worried
about losing market share. Sean Flush, the Vice President of Marketing, has prepared the
following market plans:
Plan 1:
Charge a selling price of $68; expected sales total 35,000 units; variable costs are
$24 per unit; fixed costs total $1,000,000.
Plan 2:
Charge a selling price of $60; expected sales total 42,000 units; variable costs are
$24 per unit; spend an additional $50,000 on advertising which increases total fixed
costs to $1,050,000.
Plan 3:
Charge a selling price of $54; expected sales total 54,000 units; variable costs are
reduced to $22 per unit; fixed costs total $1,160,000.
Required:
Develop a schedule showing the profit from each of the three market plans. Which would you
recommend? Why?
19. Accounting information for three different companies is provided below:
Company A
Company B
Company C
Operating revenues
$238,000
$214,000
$200,000
Net income
31,000
47,000
96,000
Total assets
198,000
285,000
445,000
Required:
a.
Which of the above companies appears to be following a cost leadership strategy?
Provide computational support for your answer.
b.
Which of the above companies appears to be following a product differentiation
strategy? Provide computational support for your answer.
c.
Which company has the highest return on assets?
Sales
Variable costs
Fixed costs
(1,000,000)
(1,050,000)
(1,160,000)
Profit
510 ♦ Chapter 14
20. Information provided below summarizes operating information for two companies:
(in thousands)
Hill
Faith
Sales
$28,000
$40,000
Cost of goods sold
24,000
30,000
Operating income
1,600
4,000
Net income
500
1,400
Accounts receivable
2,400
3,000
Inventories
2,000
2,000
Total assets
44,000
48,000
Required:
a.
Compute accounts receivable turnover and inventory turnover for each company.
b.
Compare the company’s performance during the two years.
Company A:
asset turnover:
238,000 ÷ 198,000 = 1.20 times
profit margin:
31,000 ÷ 238,000 = 13.03%
return on assets:
1.20 × 13.03% = 15.64%
Company B:
asset turnover:
214,000 ÷ 285,000 = .75 times
profit margin:
47,000 ÷ 214,000 = 21.96%
return on assets:
.75 × 21.96% = 16.47%
Company C:
asset turnover:
200,000 ÷ 445,000 = .45 times
profit margin:
96,000 ÷ 200,000 = 48%
return on assets:
.45 × 48% = 21.60%
Analysis of Operating Activities ♦ 511
21. Information provided below summarizes operating information for two companies:
(in thousands)
Leadbetter
Dixon
Sales
$20,000
$24,000
Cost of goods sold
17,000
20,000
Operating income
1,000
1,800
Net income
600
1,080
Accounts receivable
5,000
4,800
Inventories
4,800
4,700
Total assets
24,000
28,000
Required:
a.
Compute accounts receivable turnover and inventory turnover for each company.
b.
Compare the company’s performance during the two years.
Accounts receivable turnover
Inventory turnover
Accounts receivable turnover
Inventory turnover
512 ♦ Chapter 14
22. Comparative financial information for the two most recent accounting periods is provided below
for Natural Remedies, Inc.:
2008
2007
Accounts receivable
$ 1,500,000
$1,220,000
Inventory
4,260,000
2,980,000
Operating revenues
11,250,000
6,710,000
Cost of goods sold
5,538,000
2,742,000
Operating income
2,700,000
2,684,000
Gross profit
$ 5,712,000
$3,968,000
Required:
a.
Compute inventory turnover for each of the two years. Interpret your result.
b.
Compute accounts receivable turnover for each of the two years. Interpret your
result.
c.
Compute gross profit margin for each of the two years. Interpret your result.
d.
Compute operating profit margin. Interpret your result.
a.
2008 5,538 ÷ 4,260 = 1.3 times
2007: 2,742 ÷ 2,980 = .92 times
The increase in inventory turnover indicates that the firm became more effective in
using its resources.
b.
2008 11,250 ÷ 1,500 = 7.5 times
2007 6,710 ÷ 1,220 = 5.5 times
The increase in accounts receivable turnover indicates that the firm is not having
c.
2008: 5,712 ÷ 11,250 = 50.8%
2007 3,968 ÷ 6,710 = 59.1%
The decrease in gross profit margin indicates that the firm is less efficient in
producing or purchasing goods for sale.
d.
2008: 2,700 ÷ 11,250 = 24.0%
2007 2,684 ÷ 6,710 = 40.0%
Analysis of Operating Activities ♦ 513
23. Comparative financial information for the two most recent accounting periods is provided below:
2008
2007
Accounts receivable
$156,000
$105,000
Inventory
412,000
342,000
Operating revenues
952,000
861,000
Cost of goods sold
618,000
325,000
Operating income
238,000
301,000
Gross profit
334,000
536,000
Required:
a.
Compute inventory turnover for each of the two years. Interpret your result.
b.
Compute accounts receivable turnover for each of the two years. Interpret your
result.
c.
Compute gross profit margin for each of the two years. Interpret your result.
d.
Compute operating profit margin. Interpret your result.
a.
2008: 618 ÷ 412 = 1.50 times
2007: 325 ÷ 342 = .95 times
using its resources.
b.
2008: 952 ÷ 156 = 6.1 times
2007: 861 ÷ 105 = 8.2 times
c.
2008: 334 ÷ 952 = 35.08%
2007: 536 ÷ 861 = 62.25%
The decrease in gross profit margin indicates that the firm is less efficient in
d.
2008: 238 ÷ 952 = 25%
2007: 301 ÷ 861 = 35%
The decrease in operating profit margin indicates that the firm is less efficient in
controlling its selling and administrative costs.
514 ♦ Chapter 14
24. Gilmore Enterprises is considering investing in Waters, Inc. Before making their final decision,
additional information is required. The only data currently available is as follows:
6.0 times
1.45 times
2.5 times
25%
$600,000
$400,000
Required:
Use the above information to compute the following:
a.
Operating revenues
b.
Net income
c.
Profit margin
d.
Accounts receivable
e.
Return on equity
25. Southeastern Publishing has the following comparative financial information for the two most
recent accounting periods:
2008
2007
Accounts receivable
$162,000
$138,000
Inventory
394,000
248,000
Operating revenues
770,000
697,000
Cost of goods sold
414,000
335,000
Operating income
231,000
279,000
Gross profit
356,000
362,000
Required:
a.
Compute inventory turnover for each of the two years. Interpret your result.
b.
Compute accounts receivable turnover for each of the two years. Interpret your
results.
c.
Compute gross profit margin for each of the two years. Interpret your results.
d.
Compute operating profit margin. Interpret your results.
a.
Operating revenues = 1.45 × $600,000 = $870,000
b.
Net income = 25% × $600,000 = $150,000
c.
Profit margin = $150,000 ÷ $870,000 = 17.24%
d.
Accounts receivable = $870,000 ÷ 6.0 = $145,000
e.
Return on equity = 25% × ($600,000/400,000) = 37.5%
Analysis of Operating Activities ♦ 515
ESSAY
1. Define two alternative operating strategies and give a real world example of each.
516 ♦ Chapter 14
2. Define return on assets and describe the two components of which it is comprised.
3. Briefly describe the product differentiation operating strategy.
4. Briefly describe the cost leadership operating strategy.
5. Define return on equity and describe the three components of which it is comprised.
Analysis of Operating Activities ♦ 517
6. Financial statements provide information about a firm’s financing, investing, and operating
activities. Briefly describe each of these activities.
7. Identify the six steps in the accounting cycle and briefly explain the purpose of each.
8. One of the primary components of the accounting system is measurement rules. Briefly describe
three examples of measurement rules.
518 ♦ Chapter 14
9. Briefly describe the six primary components of the accounting information system.