Return on investment
Soto Corporation’s balance sheet indicates that the company has $300,000 invested in
operating assets. During 2011, Soto earned operating income of $45,000 on $600,000 of
a. Compute Soto’s profit margin for 2011.
b. Compute Soto’s turnover for 2011.
c. Compute Soto’s return on investment for 2011.
d. Recompute Soto’s ROI under each of the following independent assumptions.
(1) Sales increase for $600,000 to $750,000, thereby resulting in an increase in
operating income for $45,000 to $60,000.
(2) Sales remain constant, but Soto reduces expenses resulting in an increase in
operating income from $45,000 to $48,000.
(3) Soto is able to reduce its invested capital from $300,000 to $240,000 without
affecting operating income.
roblem1. Using present value techniques to evaluate alternative investment opportunities.
Fast Delivery is a small company that transports business packages between New York and Chicago. It operates a fleet of small vans that moves packages to and from a central depot within each city and uses a common carrier to deliver the packages between the depots in the two cities. Fast recently acquired approximately $6 million of cash capital from its owners, and its president. Don Keenon, is trying to identify the most profitable way to invest these funds.
Clarence Roy, the company’s operations manager, believes that the money should be used to expand the fleet of city vans at a cost of $720,000. He argues that more vans would enable the company to expand its services into new markets, thereby increasing the revenue base. More specifically, he expects cash inflows to increase by $280,000 per year. The additional vans are expected to have an average useful life of four years and a combined salvage value of $100,000. Operating the vans will require additional working capital of $40,000, which will be recovered at the end of the fourth year.
In contrast, Patricia Lipa, the company’s chief accountant, believes that the funds should be used to purchase large trucks to deliver the packages between the depots in the two cities. The conversion process would produce continuing improvement in operating savings with reductions in cash outflows as the following.
Year 1 Year 2 Year 3 Year 4
$160,000 $320,000 $400,000 $440,000
The large trucks are expected to cost $800,000 and to have a four-year useful life and a $80,000 salvage value. In addition to the purchase price of the trucks, up-front training costs are expected to amount to $16,000. Fast Delivery’s management has established a 16 percent desired rate of return.
a. Determine the net present value of the two investment alternatives.
b. Calculate the present value index for each alternative.
c. Indicate which investment alternative you would recommend. Explain your choice.