What financial information should the directors of a small manufacturer use when reviewing the performance of its new reusable-water-bottle product? Table 1...
Question 1 Report
What financial information should the directors of a small manufacturer use when reviewing the performance of its new reusable-water-bottle product? Table 1 compares two years after the business changed its pricing strategy and purchased a faster manufacturing machine.
| Measure | 2024 | 2025 |
|---|---|---|
| Sales revenue ($) | 600,000 | 720,000 |
| Net profit ($) | 72,000 | 64,800 |
| Capital employed ($) | 400,000 | 540,000 |
(a) Show the calculation of return on capital employed (ROCE) for 2025. [2]
(b) Which year had the higher net profit margin? [1]
(c) Explain one reason why the directors should compare ROCE before buying another machine. [3]
Answer Details
(a) Return on capital employed measures the percentage return the business earns from the long-term capital invested in it. Use net profit divided by capital employed:
\[\text{ROCE}=\frac{\$64{,}800}{\$540{,}000}\times100=12\%\]
This is the required calculation and answer. [2]
(b) Net profit margin is \(\text{net profit}\div\text{sales revenue}\times100\). For 2024:
\[\frac{\$72{,}000}{\$600{,}000}\times100=12\%\]
For 2025, \(\$64{,}800\div\$720{,}000\times100=9\%\). Therefore, 2024 had the higher net profit margin, at 12%. [1]
(c) Directors should compare ROCE because it shows how efficiently capital employed is generating profit. [1] It lets them compare the return from their existing investment with the likely return from buying a further machine. [1] Here, a low or falling ROCE could indicate that the business is not using capital effectively, so committing more capital to another machine may not be worthwhile. [1]
Examination reminder: Do not confuse profit with profitability. ROCE relates profit to the capital invested, whereas net profit margin relates profit to sales revenue.
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