Return on assets: = net income/total assets
ROA= $12000/$100000 =0.12
Proposed results without cannibalization:
ROA= $13000/$100000= 0.13
Proposed results with cannibalization:
ROA= $12000/$100000 = 0.12
Profit margin: = Net income/ sales
= $12000/$45000= 0.267
Proposed results without cannibalization
= $13000/$60000= 0.217
Proposed results with cannibalization
Asset turnover: = Net sales/ Average Fixed assets
Proposed without cannibalization
= $60000/ $100000= 0.6
Proposed results without cannibalization
= $50000/$100000= 0.5
Implications of the results concerning Denver’s decision
The decision would be affected based on the values obtained in each of the cases above. This, each type of the ratio will determine the likely decision and conclusion that Denver would make. The return on assets would affect the decision made. In this case, it is probable that the return on assets would increase with the adoption of the new line of production. This is indicated by the increase of ROA from 0.12 to 0.13 without cannibalization. However, the decision would be in-differential where cannibalization would be expected to occur. Therefore, the probability would be taken into account for an effective decision making. The management would decide to adopt the new line of products where cannibalization would not be expected. This is because such would increase the return on assets from the current situation. If the cannibalization were expected, the decision would be to remain in the current situation as the return on assets would not change.
On the other hand, the assets turnover represents a ratio that measures the efficiency of an organization in using its assets in the generation of sales revenue. Thus, the higher the asset turnover ratio, the higher the effectiveness of the organization is expected. Therefore, this would affect the decision adopted by the organization. With the current results, the asset turnover ratio reads at 0.45. With the introduction of a new product line, the asset turnover rate would increase in either the presence of cannibalization as well as the absence of the same. Without cannibalization, the asset turnover ratio would rise to 0.6 while with cannibalization taking effect, the asset turnover ratio would increase to 0.5. Considering the assets turnover ratio in isolation, Denver would decide to proceed with the introduction of the new product line (Cassar et al, 2015). The reason is that the introduction would increase the efficiency of the organization in the use of the assets for the generation of the sales. Improving the efficiency would mean that more sales would be made with limited costs.
Profit margin ratio would also influence the decision made by the management. In this case, the profit margin under the current results amounts to 0.267. The profit margin under the proposed instruction of a product line is 0.217 and 0.24 without cannibalization and with cannibalization respectively. The reason is that the introduction of the new product would render the entire business to incur a reduction in the level of profits. While considering the profit margin behavior in isolation, the management would decide between leaving out the introduction of the new product. This is because the current results present higher profits than in the new product line era. It is the aim of all organization to maximize their profits. Therefore, other factors remain constant when the level of profits is being affected. Profit maximization, thus, would determine the overall decision made by the management at the end. The choice would be to drop the new product proposal and operate as the current conditions dictate.
Other options and their effect on the ratios
There would be other options that the organization could take into consideration. First, Denver could consider adding up to the level of assets in the organization to ensure that the level of production is improved. This would, in turn, increase the asset turnover ratio. The asset turnover ratio would increase with an increase in the level of the assets (Francis et al, 2015). This would be an indication of a higher level of efficiency in the production of the various products of the organization. An increase in productivity would work in the reduction of the operational costs involved. However, an increase in the level of assets would reduce the profit margin ratio. This is because more revenues would be utilized in the purchase of the new assets into the company. The purchase cost would then be too high as compared to the rate of income. An increase in the assets would increase the costs of production, thus reducing the level of organizational profits.
Denver would also have an option of marketing the existing products better as opposed to including the new product line in the organization. This would call for the use of more revenues in the marketing techniques and approaches (Kou et al, 2014). At the end of the procedures adopted, the company would make more sales to the existing as well as in the new markets. An increase in the sales revenue would mark an increase in the profit margin. This would work well for the organization as it would earn more for use in the reinvestments.
The decision made Denver makes depends on the direction of success that the various financial ratios dictate. If the financial ratios promise the organization an increase in the shareholders net worth, Denver management will consider taking up the appropriate decision. In this case, an increase in the profit margin would make the managers adopt a new product line. If the product line holds a reduction in the level of profits, the managers will consider leaving such in favor of the current form of operations.
Cassar, G., Ittner, C. D., & Cavalluzzo, K. S. (2015). Alternative information sources and information asymmetry reduction: Evidence from small business debt. Journal of Accounting and Economics, 59(2-3), 242-263.
Francis, B., Hasan, I., Park, J. C., & Wu, Q. (2015). Gender differences in financial reporting decision making: Evidence from accounting conservatism. Contemporary Accounting Research, 32(3), 1285-1318.
Kou, G., Peng, Y., & Wang, G. (2014). Evaluation of clustering algorithms for financial risk analysis using MCDM methods. Information Sciences, 275, 1-12.