Question

Question: Using ROI and RI to evaluate investment centers

This problem continues the Piedmont Computer Company situation from Chapter 23. Piedmont Computer Company reported 2020 sales of \(3,600,000 and operating income of \)183,600. Average total assets during 2020 were $600,000. Piedmont Computer Company’s target rate of return is 16%.

Calculate Piedmont Computer Company’s profit margin ratio, asset turnover ratio, ROI, and RI for 2020. Comment on the results.

Short answer

Answer

Company’s profit margin ratio is 0.051 or 5.1%. It means of the sales revenue i.e., 100%, 5.1% is left as net income after meeting cost of goods sold and all operating expenses.

Company’s asset turnover ratio 6:1 it shows the efficiency of asset to generate sales revenue.

Return on investment of the company for the year is 30.6% and residual income is $87,600.

Step-by-step solution

Step 1:

$$\begin{gathered} \text{Profit margin ratio}=\frac{\text{Net income}}{\text{Net sales revenue}} \\ =\frac{\$183,600}{\$3,600.000} \\ =0.051 \end{gathered}$$

Step 2:

$$\begin{gathered} \text{Asset Turnover Ratio}=\frac{\text{Net Sales}}{\text{Average Total Assets}} \\ =\frac{\$3,600,000}{\$600,000} \\ =6 \end{gathered}$$

Step 3:

$$\begin{gathered} \text{ROI}=\frac{\text{Net income}}{\text{Average total asset}}\times 100 \\ =\frac{\$183,600}{\$600,000}\times 100 \\ =30.6\% \end{gathered}$$

Step 4:

$$\begin{gathered} \text{Residual Income}=\text{Operating income}-\left(\text{Minimum required rate of return}\times \text{Average operating assets}\right) \\ =\$183,600-\left(16\%\times \$600,000\right) \\ =\$183,600-\$96,000 \\ =\$87,600 \end{gathered}$$