Solution 17.2

Outline the effect each of the following decisions would have on the return on capital employed ratio.

Increasing sales price will improve gross and net profit margins and as long as the price increase has does not adversely affect volume sales and the total asset turnover ration then operating profit should improve.

Paying off a long-term loan with cash in hand will ensure a business will have the effect of reducing loan interest and thus increasing profit and the return on capital employed. However management should assess whether redeeming a loan is the best option to take as they may be foregoing some very profitable investments that could ensure and even higher returns

Reducing fixed costs in the income statement will have a positive effect on the return on capital employed as long as these cost reduction do not deteriorate the quality of the product or service offered by the business. Should this happen then sales and profitability would be adversely affected.

Arranging an overdraft facility will have no effect on return on capital employed as it is only a facility arranged. However should a business use a overdraft facility excessively due to bad management of working capital then loan interest would increase and this would reduce the ROCE.