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Chapter 24: Q4TI (page 1346)

Padgett Company has compiled the following data:

Net sales revenue $1,000,000

Operating income 60,000

Average total assets 400,000

Management’s target rate of return 12%

Compute the following amounts for Padgett:

  1. Profit margin ratio
  2. Asset turnover ratio
  3. Return on investment
  4. Residual income

Short Answer

Expert verified

The profit margin ratio of the company is6%.

The asset turnover ratio is2.5 times.

Return on investment is15%.

Residual income of the company is$12,000.

Step by step solution

01

Meaning of Operating income

Operating income refers to the income generated by a business concern from its core operations. It is computed by taking the difference betweensales revenue and associated costs such as variable and fixed.

02

Computation of profit margin ratio

Profitmarginratio=OperatingincomeNetsales×100=$60,000$1,000,000×100=6%

03

Computation of asset turnover ratio

Assetturnoverratio=NetsalesAveragetotalassets=$1,000,000$400,000=2.5times

04

Computation of return on investment

Returnoninvestment=OperatingincomeAveragetotalassets×100=$60,000$400,000×100=15%

05

Computation of residual income

Residualincome=Operatingincome-(Targetrateofreturn×Averagetotalassets)=$60,000-(12%×$400,000)=$60,000-$48,000=$12,000

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Most popular questions from this chapter

What is a key performance indicator?

Consider the following key performance indicators, and classify each indicator according to the balanced scorecard perspective it addresses. Choose from the financial perspective, customer perspective, internal business perspective, and the learning and growth perspective.

a. Number of customer complaints

b. Number of information system upgrades completed

c. Residual income

d. New product development time

e. Employee turnover rate

f. Percentage of products with online help manuals

g. Customer retention

h. Percentage of compensation based on performance

i. Percentage of orders filled each week

j. Gross margin growth

k. Number of new patents

l. Employee satisfaction ratings

m. Manufacturing cycle time (average length of production process)

n. Earnings growth

o. Average machine setup time

p. Number of new customers

q. Employee promotion rate

r. Cash flow from operations

s. Customer satisfaction ratings

t. Machine downtime u. Finished products per day per employee

v. Percentage of employees with access to upgraded system

w. Wait time per order prior to start of production

Financial performance is measured in many ways.

Requirements

1. Explain the difference between lag and lead indicators.

2. The following is a list of financial measures. Indicate whether each is a lag or a lead indicator:

a. Income statement shows net income of \(100,000

b. Listing of next week’s orders of \)50,000

c. Trend showing that average hits on the redesigned Web site are increasing at 5% per week

d. Price sheet from vendor reflecting that cost per pound of sugar for the next month is $2

e. Contract signed last month with large retail store that guarantees a minimum shelf space for Grandpa’s Overloaded Chocolate Cookies for the next year

Refer to the information in Short Exercise S24-7.

Requirements

1. Compute each division’s asset turnover ratio (round to two decimal places). Interpret your results.

2. Use your answers to Requirement 1, along with the profit margin ratio, to recalculate ROI using the expanded formula. Do your answers agree with the basic ROI in Short Exercise S24-7?

Grandpa Jim’s Cookie Company sells homemade cookies made with organic ingredients. His sales are strictly Web based. The business is taking off more than Grandpa Jim ever expected, with orders coming from across the country from both consumers and corporate event planners. Grandpa decides to decentralize and hires a full-time baker who will manage production and product costs and a Web site designer/sales manager who will focus on increasing sales through the Web site. Grandpa Jim can no longer handle the business on his own, so he hires a business manager to work with the other employees to ensure the company is best utilizing its assets to produce profit. Grandpa will then have time to focus on new product development. Now that Grandpa Jim’s Cookie Company has decentralized, identify the type of responsibility center that each manager is managing
See all solutions

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