Question

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

10-a. If Westerville’s chief executive officer will earn a bonus only if her ROI from this year exceeds her ROI from last year, would she pursue the investment opportunity? (Y/N)

10-b. Would the owners of the company want her to pursue the investment opportunity? (Y/N)

11. What is last year’s residual income?

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

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

14. If Westerville’s chief executive officer will earn a bonus only if her residual income from this year exceeds her residual income from last year, would she pursue the investment opportunity? (Y/N)

15-a. Assume that the contribution margin ratio of the investment opportunity was 50% instead of 60%. If Westerville’s Chief Executive Officer will earn a bonus only if her residual income from this year exceeds her residual income from last year, would she pursue the investment opportunity? (Y/N)

5-b. Would the owners of the company want her to pursue the investment opportunity? (Y/N)

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

Sales	$	1,500,000
Variable expenses		500,000
Contribution margin		1,000,000
Fixed expenses		700,000
Net operating income	$	300,000
Average operating assets	$	1,000,000

At the beginning of this year, the company has a $200,000 investment opportunity with the following cost and revenue characteristics:

Sales	$	300,000
Contribution margin ratio		60	% of sales
Fixed expenses	$	132,000

The company’s minimum required rate of return is 10%.

Answer 1

9) ROI = operating income / avergae operaitng assets

	Last year	New opportunity	Total
Operating income	$3,00,000	$48,000	$3,48,000
Investment	$10,00,000	$2,00,000	$12,00,000

This years ROI = 348000 / 1200000

= 29%

10a) ROI last year = 300000 / 1000000

= 30%

This years ROI is 29%.

No, Westerville's CEO will not persue this opportunity becuase this years ROI has decreased last years ROI by 1% and hence the CEO will not be entitled to any bonus.

10b) Yes, the owners of the company will want her to persue this oppotunity as the investment base in increasing and the ROI may increase in the future.

11) Residual income = operating income - (minimum required rate of return * operating assets)

Last years residual income = 300000 - (10%*1000000)

= $200,000

12) Residual incme of this years investment opportunity = 48000 - (10%*200000)

= $28,000

13) Residual income this year = 348000 - (10% * 1200000)

= $228,000