Question

Review the chapter’s opening feature involving Matt Hofmann and his company, Westland Distillery. Assume that the company currently has net sales of \(8,000,000 and that it is planning an expansion that will increase net sales by \)4,000,000. To accomplish this expansion, Westland Distillery must increase its average total assets from \(2,500,000 to \)3,000,000.

Required

1. Compute the company’s total asset turnover under (a) current conditions and (b) proposed conditions.
2. Evaluate and comment on the merits of the proposal given your analysis in part 1. Identify any concerns you would express about the proposal.

Short answer

1. Total asset turnover in current conditions is 3.2 and in proposed condition is 4.
2. The company’s plan regarding the expansion is a very beneficial.

Step-by-step solution

Asset turnover ratio

The asset turnover ratio is a profitability ratio. It measures how efficiently a company uses its assets to generate sales.

$\mathit{t}\mathit{o}\mathit{t}\mathit{a}\mathit{l}\mathbf{}\mathit{a}\mathit{s}\mathit{s}\mathit{e}\mathit{t}\mathbf{}\mathit{t}\mathit{u}\mathit{r}\mathit{n}\mathit{o}\mathit{v}\mathit{e}\mathit{r}\mathbf{}\mathit{r}\mathit{a}\mathit{t}\mathit{i}\mathit{o}\mathbf{=}\frac{\mathbf{n}\mathbf{e}\mathbf{t}\mathbf{}\mathbf{s}\mathbf{a}\mathbf{l}\mathbf{e}\mathbf{s}}{\mathbf{a}\mathbf{v}\mathbf{e}\mathbf{r}\mathbf{a}\mathbf{g}\mathbf{e}\mathbf{}\mathbf{t}\mathbf{o}\mathbf{t}\mathbf{a}\mathbf{l}\mathbf{}\mathbf{a}\mathbf{s}\mathbf{s}\mathbf{e}\mathbf{t}}$

Computation of total asset turnover

(a) Under current conditions

$totalassetturnover=\frac{\$8,000,000}{\$2,500,000}$

$\mathit{t}\mathit{o}\mathit{t}\mathit{a}\mathit{l}\mathbf{}\mathit{a}\mathit{s}\mathit{s}\mathit{e}\mathit{t}\mathbf{}\mathit{t}\mathit{u}\mathit{r}\mathit{n}\mathit{o}\mathit{v}\mathit{e}\mathit{r}\mathbf{=}\mathbf{3}\mathbf{.2}$

(b) Under the proposed condition

$totalassetturnover=\frac{\$12,000,000}{\$3,000,000}$

$\mathit{t}\mathit{o}\mathit{t}\mathit{a}\mathit{l}\mathbf{}\mathit{a}\mathit{s}\mathit{s}\mathit{e}\mathit{t}\mathbf{}\mathit{t}\mathit{u}\mathit{r}\mathit{n}\mathit{o}\mathit{v}\mathit{e}\mathit{r}\mathbf{=}\mathbf{4}$

Merits of the proposal

The company’s plan regarding the expansion is a very beneficial proposalas it increases the total asset turnover from 3.2 to 4. Now company more efficiently uses assets and increases the sales as well.