# Respond to two classmate post in Financial Analysis Course

CLASSMATE REPSONSE 1:

Accountants often express ROI as the product of two components – capital turnover and return on sales.  You are considering investing in one of three companies, all in the same industry, and are given the above information.

1.  Why would you desire the breakdown of ROI into return on sales and turnover on capital?

The reason we would desire such a breakdown is because those are the two items that calculate ROI.  The formula is ROI = return on sales X capital turnover.  Increasing either of those items will lead to an increase of ROI (MSA 602, 339).

2.  Compute the return on sales, turnover on capital, and ROI for three companies, and comment on the relative performance of the companies as thoroughly as the data permits:

Please see calculations in green on above table.  The following formulas were used:

Return on sales = income / revenue
Turnover on capital = revenue / invested capital
ROI = return on sales X turnover on capital

Adam is performing by far the best.  At an ROI of 24%, Adam is generating income of \$.24 for every dollar invested.  Two factors are driving this success:  A high income (driving increased return on sales) and a lower capital (driving increased turnover on capital).

Basil and Colin have similar ROIs at 2%.  The reason for their struggles differ greatly.  While both have a high amount of invested capital, the drastic difference in revenue is the major effect.  While Collin has a huge amount of revenue, the low amount of income generated negatively impacts return on sales.  And while Basil has a solid return on sales, the low revenue amount negatively impacts turnover on capital.

CLASSMATE POST 2:

Princeton International should use the variable cost of 500 to minimize its taxes. This is the tax minimizing price because it results in the lowest amount of total taxes. In addition, the variable cost of 500 saves costs for all segments of the company.

The transfer price of 500 results in a total tax of 515.87. The transfer price of 800 would result in total tax of 825.39. The transfer price of 500 provides a total tax that is over 300 lower that a transfer price of 800.