Question

1. During 2016, Energy Corp. fully impaired a generation facility that represented 5% of its total assets (i.e., reported an impairment loss and reduced the book value of the asset). What will be the effect of this impairment on Energy’s asset turnover (using the average balance in the balance sheet) and operating profit margin in 2016?

A. Asset turnover will decrease and net income margin will decrease.
B. Asset turnover will increase and net income margin will increase.
C. Asset turnover will decrease and net income margin will increase.
D. Asset turnover will increase and net income margin will decrease.

Answer 1

The correct answer is C. Asset turnover will decrease and net income margin will increase.

Asset turnover is calculated by dividing total revenue by average assets. By impairing the generation facility, the total assets of Energy Corp. will decrease, which will result in a decrease in the denominator of the asset turnover ratio. Therefore, the asset turnover will decrease.

Operating profit margin is calculated by dividing operating profit by total revenue. As the generation facility was fully impaired, it will no longer generate any operating profit, which will reduce the numerator of the operating profit margin ratio. Therefore, the operating profit margin will increase.