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Raney Industries – Controllable Margin and Return on Investment

The service division of Raney Industries reported the following results for 2017.

Sales$532,400
Variable costs$319,440
Controllable fixed costs$87,300
Average operating assets$623,500

Management is considering the following independent courses of action in 2018 in order to maximize the return on investment for this division.

1. Reduce average operating assets by $129,900, with no change in the controllable margin.

2. Increase sales by $106,500, with no change in the contribution margin percentage.

a. Compute the controllable margin and the return on investment for 2017.

b. Compute the controllable margin and the expected return on investment for each proposed alternative.

Controllable Margin and Return on Investment:

When a company organizes its activities in investment centers, it calculates the controllable margin (controllable operating income) for each investment center and then uses tools like return on investment to evaluate the center’s performance and provide feedback to its management.

Answer and Explanation:

a. The controllable margin is the difference between the contribution margin and the controllable fixed costs:

Sales$532,400
Variable costs$319,440
Contribution margin$212,960
Controllable fixed costs$87,300
Controllable margin$125,660
Average operating assets$623,500
Return on investment = Controllable margin / Average operating assets= $125,660 / $623,500
20.15%

b. We must adjust the relevant line items for each course of action. Note that variable costs is currently $319,440 / $523,400 = 60% of sales revenue, meaning the contribution margin ratio is 40%:

CurrentReduce assetsIncrease sales
Sales$532,400$532,400= $532,400 + $106,500 = $638,900
Variable costs$319,440$319,440= $638,900 × 0.60 = $383,340
Contribution margin$212,960$212,960$255,560
Controllable fixed costs$87,300$87,300$87,300
Controllable margin$125,660$125,660$168,260
Average operating assets$623,500= $623,500 – $129,900 = $493,600$623,550
Return on investment = Controllable margin / Average operating assets= $125,660 / $623,500
20.15%
= $125,660 / $493,600
25.46%
= $168,260 / $623,500
26.98%

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