Question

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

Sales	$	2,000,000
Variable expenses		640,000
Contribution margin		1,360,000
Fixed expenses		860,000
Net operating income	$	500,000
Average operating assets	$	1,250,000

This year, the company has a $250,000 investment opportunity with the following cost and revenue characteristics:

Sales	$	400,000
Contribution margin ratio		70	% of sales
Fixed expenses	$	220,000

The company’s minimum required rate of return is 10%. 6. What is the ROI related to this year’s investment opportunity? 7. If the company pursues the investment opportunity and otherwise performs the same as last year, what margin will it earn this year? (Round your percentage answer to 1 decimal place (i.e .1234 should be entered as 12.3)) 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? (Round your percentage answer to 1 decimal place (i.e .1234 should be entered as 12.3)) 10. 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? Yes No 10-b. Would the owners of the company want her to pursue the investment opportunity? Yes No

Answer 1

Solution 6:

contribution related to new investmen opportunity = $400,000 * 70% = $280,000

Net Operating income related to new investment opportunity = $280,000 - $220,000 = $60,000

ROI related to new investment opportunity = Net Operating income / Investment

= $60,000 / $250,000 = 24%

Solution 7:

If company pursues the investment opportunity and otherwise performs the same as last year then total sales for current year = $2,000,000 + $400,000 = $2,400,000

Net Operating income for the current year = $500,000 + $60,000 = $560,000

Margin = Net Operating income / Sales = $560,000 / $2,400,000 = 23.3%

Solution 8:

If company pursues the investment opportunity and otherwise performs the same as last year then total sales for current year = $2,000,000 + $400,000 = $2,400,000

Total average operating assets = $1,250,000 + $250,000 = $1,500,000

Asset turnover = Sales / Average total assets = $2,400,000 / $1,500,000 =1.60 times

Solution 9 :

If the company pursues the investment opportunity and otherwise performs the same as last year, ROI for this year = Margin * Turnover = 23.3% * 1.60 = 37.3%

Solution 10 a:

ROI for last year = $500,000 / $1,250,000 = 40%

As ROI for current year will decrease from ROI of last year if company pursue investment opportunity, therefore Westerville’s chief executive officer will not pursue the investment opportunity.

Solution 10b:

As ROI provided by new investment opportunity is higher than minimum required return of the company, therefore owner of the company want her to pursue the investment opportunity.