Question

Lisa, a buyer at JB Carry & Co Inc., is recommending an outsourcing option to company management. As part of her presentation, Lisa wants to demonstrate the powerful effects of lowering company costs through outsourcing as opposed to alternatives, such as increasing sales. Lisa obtains the following information from the company’s financial reports.

Sales:	$620,000
COGS:	$490,000
Assets:	$940,000
Net profits (before tax and interest):	$ 67,00

Compute the following metrics on the purchasing multiplier (PM), the purchasing leverage effect (PLE), and the return on assets (ROA) effect. Complete the table.
Important: Round your answers to two decimal places (Enter as ##.00 or #.00)

What increase in the volume of sales would have the same effect as a $1.00 decrease in purchase cost? (PM) (Enter as #.00)	$
Assume that a reduction of purchase costs by approximately 6% increases profits by $30,000. What is the profit leverage effect in this case? (Enter as ##.00)	%
Assume that the reduction in purchase costs also leads to a lower inventory valuation and thus decreases the firm’s assets by $12,000 to $928,000.
What is the ROA before the reduction in purchase costs? (Enter as #.00)	%
What is the ROA after the reduction in purchase costs? (Enter as #.00)	%

Answer 1

Solution: a Increase in the volume of sales if purchase cost decreases by $1.00 (W.N.-2) - ($130,001- $130,000)/0.2097 - $4.77 b Profit leverage effect($96,400 $67,000)/67,000 43.88% c ROA before the reduction in purchase costs (W.N.-1) - Net Profit/ Assets 67,000 / 940,000 7.13% d ROA after the reduction in purchase costs (W.N. -3) - Net Profit/ Assets - $96,400/928,000 -10.39% Working Notes (W.N): Particulars Amount $ 620,000 $ 490,000 $130,000 Percentage Sales COGS Gross Profit Less: Operating Expenses 63,000 EBIT 100.00% 79.03% 20.97% 10.16% 10.81% $67,000 Assets $ 940,000 Working Notes (W.N) Particulars Amount Percentage Sales COGS Gross Profit Less: Operating Expenses 63,000 EBIT 620,000 $ 489,999 $130,001 100.00% 79.03% 20.97% 10.16% 10.81% $67,001 Working Notes (W.N): Particulars Amount Percentage Sales COGS Gross Profit Less: Operating Expenses 63,000 EBIT 620,000 $460,600 $159,400 100.00% 74.29% 25.71% 10.16% 15.55% $96,400 Assets ($940,000 $12,000) - $ 928,000