In 2013, the Mandarin Division of Key Products Corporation generated an operating income of $3,000,000 from $20,000,000 of sales revenues and using assets worth $15,000,000.
Mandarin managers are evaluated and rewarded on the basis of ROI defined as operating income divided by total assets. Key Products Corporation expects its divisions to increase ROI each year.
The year 2014 appears to be a difficult year for Mandarin. Mandarin Division had planned new investments to improve quality but, in view of poor economic conditions, has postponed the investment. ROI for 2013 was certain to decrease had Mandarin made the investment. Management is now considering ways to meet its target ROI of 22% for next year. It anticipates revenue to be steady at $20,000,000 in 2013.
INSTRUCTIONS
Form groups of two or more students to complete the following requirements:
1. Calculate Mandarin Division return on sales (ROS) and ROI for 2013.
2. a. By how much would Mandarin have to cut costs in 2014 to achieve its target ROI of 22% in 2014, assuming no change in total assets between 2013 and 2014?
b. By how much would Mandarin have to decrease total assets in 2014 to achieve its target ROI of 22% in 2014, assuming no change in operating income between 2013 and 2014?
3. Calculate Mandarin's RI in 2013 assuming a required rate of return on investment of 18%.
4. Mandarin wants to increase RI by 30% in 2014. Assuming it could cut costs by $30,000 in 2014, by how much would Mandarin have to decrease total assets in 2014?
5. Key Products Corporation is concerned that the focus on cost cutting and asset sales will have an adverse long-run effect on Mandarin's customers. Yet Key Products Corporation wants Mandarin to meet its financial goals. What other measurements, if any, do you recommend that Key Products use? Explain briefly.