Howe Company increased its ROI from 20% to 25%. Net operating income and sales remained at their previous levels of $40,000 and $1,000,000 respectively. The increase in ROI was attributed to a reduction in operating assets brought about by the sale of obsolete inventory at cost (the proceeds from the sale were used to reduce bank loans). By how much was inventory reduced?A) $8,000B) $40,000C) $10,000D) it is impossible to determine from the data given.

First, we have to know the amount of the previous year’s average asset for us to figure out, we need to divide $40,000 by 20% (from the formula ROI = Operating income/average asset).

$40,000/20% = $200,000 (previous year’s average asset)

Second, we need to know how much is the current average asset amount. Since the net operating income is still the same, we will use $40,000 as our net operating income for the current year.

$40,000/25% = $160,000 (current year’s asset

lastly, as per data given, the only changes happened in our average asset is the sale on obsolete inventory. We will deduct current year’s average asset from the previous year for us to know the how much the inventory was reduced.

$200,000 - $160,000 = $40,000

dubeyshailja64 dubeyshailja64 · Answer 2 · 2022-02-23T10:01:53+01:00

The value by which the inventory decreased is $40,000.

What is ROI?

ROI or return on investment is a profitability measure. It calculates the profitability of an investment or simply the amount of return that can be earned from a particular investment. It therefore helps in taking investment decisions.

It is calculated in percentage. The formula to calculate ROI is:

[tex]\rm ROI = \dfrac{Operating\:Income}{Net\:Assets}[/tex]

Given:

Net operating income is $40,000

Sales is $1,000,000

The ROI for previous level is 20%

The ROI for current level is 25%

The value of net assets can be calculated using ROI formula. The value of net assets of previous level is:

[tex]\begin{aligned}\rm ROI &= \rm \dfrac{Operating\:Income}{Net\:Assets}\\\\\rm 20\% &=\rm \dfrac{\$40,000}{Net\:Assets}\\\\\rm Net\:Assets&= \dfrac{40,000}{20\%}\\\\\rm Net\:Assets&= \$200,000\end[/tex]

Similarly the net assets for current level is:

[tex]\rm Net\:Assets&= \dfrac{40,000}{25\%}\\\\\rm Net\:Assets&= \$160,000\end[/tex]

It is given that the decrease in net assets was a reason of reduced inventory. Therefore the reduction in inventory is:

[tex]\rm Reduction\:in\:inventory = \$200,000-\$160,000\\\\\rm Reduction\:in\:inventory = \$40,000[/tex]

Therefore the correct option is B.

Learn more about ROI here:

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