Question

Westerville Company reported the following results from last year’s operations:

Sales	$	1,400,000
Variable expenses		720,000
Contribution margin		680,000
Fixed expenses		470,000
Net operating income	$	210,000
Average operating assets	$	875,000

At the beginning of this year, the company has a $350,000 investment opportunity with the following cost and revenue characteristics:

Sales	$	560,000
Contribution margin ratio		70	% of sales
Fixed expenses	$	336,000

The company’s minimum required rate of return is 15%.

1. What is the ROI related to this year’s investment opportunity?

2. If the company pursues the investment opportunity and otherwise performs the same as last year, what margin will it earn this year?

3. If the company pursues the investment opportunity and otherwise performs the same as last year, what turnover will it earn this year?

4. If the company pursues the investment opportunity and otherwise performs the same as last year, what ROI will it earn this year?

5. What is last year’s residual income?

6. What is the residual income of this year’s investment opportunity?

Answer 1

1. What is the ROI related to this year’s investment opportunity?
Net operating income for investment opportunity	560000*70%-336000	$56,000
Margin	$56,000 / $560,000	10%
Turnover	$560,000 / $350,000	1.60 times
ROI	Margin * Turnover	10% * 1.6
		16%
2. If the company pursues the investment opportunity and otherwise performs the same as last year, what margin will it earn this year?
Total operating income for next year	$210,000 + $56,000	$266,000
Total sales for next year	$1,400,000 + $560,000	$1,960,000
Average operating assets for next year	$875,000 + $350,000	$1,225,000
Margin	$266,000 / $1,960,000	13.57%
3. If the company pursues the investment opportunity and otherwise performs the same as last year, what turnover will it earn this year?
Turnover	$1,960,000 / $1,225,000	1.6 times
4. If the company pursues the investment opportunity and otherwise performs the same as last year, what ROI will it earn this year?
ROI	13.57% * 1.6	21.71%
5. What is last year’s residual income?
Residual Income	Net Operating Income-Operating Assets*Required Rate of Return
	$210000-875000*15%
	$210000-$131250
	$78,750
6. What is the residual income of this year’s investment opportunity?
	Net Operating Income-Operating Assets*Required Rate of Return
	(560000*70%-336000)-350000*15%
	$56000-$52500
	$3,500