Question

ZNet Co. is a web-based retail company. The company reports the following for 2017.

The company’s CEO believes that sales for 2018 will increase by 20% and both profit margin (%) and the level of average invested assets will be the same as for 2017.

Sales	$5,000,000
Operating income	1,000,000
Average invested assets	12,500,000

1. Compute return on investment for 2017.

2. Compute profit margin for 2017.

3. If the CEO’s forecast is correct, what will return on investment equal for 2018?

4. If the CEO’s forecast is correct, what will investment turnover equal for 2018?

Short answer

1. Return on investment for 2017:8%

2. Profit margin for 2017:20%

3. Forecasted return on investment for 2018:9.6

4. Forecasted investment turnover for 2018:0.48%

Step-by-step solution

Definition of Operating Assets

The assets that are acquired to employ them in business operations are known as operating assets. The average of these assets is used to determine investment turnover.

Calculation of return on investment

$$\begin{gathered} \text{Returnoninvestment}=\text{Profitmargin}\times \text{Investmentturnover} \\ =20\%\times 0.4 \\ =8\% \end{gathered}$$

Working note:

Calculation of investment turnover:

$$\begin{gathered} \text{Investmentturnover}=\frac{\text{Sales}}{\text{Averageassets}} \\ =\frac{\$5,000,000}{\$12,500,000} \\ =0.4 \end{gathered}$$

Calculation of profit margin

$$\begin{gathered} \text{Profitmargin}=\frac{\text{Operatingprofit}}{\text{Averageassets}} \\ =\frac{\$1,000,000}{\$5,000,000}\times 100 \\ =20\% \end{gathered}$$

Return on investment for 2018 if forecast is correct

Return on investment = Profit margin $\times$Investment turnover

= 20% $\times$0.48

= 9.6%

Investment turnover if forecast is correct

$$\begin{gathered} I\text{nvestmentturnover}=\frac{\text{Sales}\times 120\%}{\text{Averageassets}} \\ =\frac{\$5,000,000\times 120\%}{\$12,500,000} \\ =0.48 \end{gathered}$$