Question

Westerville Company reported the following results from last year’s operations: Sales $ 1,800,000 Variable expenses 740,000 Contribution margin 1,060,000 Fixed expenses 700,000 Net operating income $ 360,000 Average operating assets $ 1,200,000 This year, the company has a $400,000 investment opportunity with the following cost and revenue characteristics: Sales $ 600,000 Contribution margin ratio 60 % of sales Fixed expenses $ 288,000 The company’s minimum required rate of return is 10%.

8. If the company pursues the investment opportunity and otherwise performs the same as last year, what turnover will it earn this year? (Round your answer to 2 decimal places.)

9. If the company pursues the investment opportunity and otherwise performs the same as last year, what ROI will it earn this year? (Do not round intermediate calculations. Round your percentage answer to 1 decimal place (i.e., 0.1234 should be entered as 12.3%))

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?

Answer 1

We need to first find the margin for this year

Margin = Net operating income /Sales

= $360000+($600000*60%-$288000)/($1800000+$600000)

= $432000/$2400000

= 18%

8) Turnover = Sales/Average operating Assets

= $1800000+$600000/($1200000+400000)

= $2400000/$1600000

= 1.5 times

9) ROI = Margin * Turnover

= 18%*1.5

= 27%

11)Last year's residual income is calculated below:

Average Operating Assets $1200000

Net operating income $360000

Minimum Required return($1200000*10%) ($120000)

Residual income $240000

12)Residual income of this year’s investment opportunity is calculated below:

Average operating assets $400000

*Net operating income $72000

Minimum required rate(10%*$400000) ($40000)

Residual income $32000

13)If the company pursues the investment opportunity and otherwise performs the same as last year, then residual income will it earn this year is below

Average Operating Assets ($1200000+400000) $1600000

Net Income ($360000+$72000) $432000

Required Rate(10%*1600000) $(160000)

Residual Income $272000

Note: Net income this year = Contribution - Fixed cost

= $600000*60%-$288000 = $72000