Question

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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

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%. 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?

Answer 1

12)	Residual income for this year investment oppurtunity is :
	Average operating assets	350000
	Net operating income
	Sales	560000
	(-) Variable cost	168000
	Contribution	392000
	(-) Fixed cost	336000
	Net operating income	56000
	Minimum required return	52500
	(350000*15%)
	Residual income = 56000-52500	3500
13)	if the company pursues the investment oppurtunity and otherwise performs the same as last year, residual income will be :
	Average operating assets	1225000
	(875000+350000)
	Net operating income	266000
	(210000+56000)
	Minimum required return	183750
	(1225000*15%)
	Residual income = 266000-183750	82250