Question

1Westerville 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%

1. What is last years Margin? (percent)

2. What is last year’s turnover?

3. What is last year’s return on investment (ROI)?

4.

What is the margin related to this year’s investment opportunity?(percent) 5. What is the turnover related to this year’s investment opportunity? 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? 8. If the company pursues the investment opportunity and otherwise performs the same as last year, what turnover will it earn this year?

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

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?

10-b. Would the owners of the company want her to pursue the investment opportunity?

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?

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?

5-b. Would the owners of the company want her to pursue the investment opportunity?

Answer 1

1) The Margin is Contribution to Sales Ratio, hence the company's margin as a percentage for last year is 66.67% {(Contribution/ Sales) * 100 = ($1,000,000/ $1,500,000) * 100}

2) Turnover is another name for Sales, hence, the company's Sales for last year is $1,500,000/-

3) The return on investment (ROI) = (Net Operating Income/ Average Operating Assets) * 100 = ($300,000/$1,000,000) * 100 = 30%

4) Contribution Margin = (Sales * Contribution Margin Ratio) = ($300,000*60%) = $180,000/-

5) Turnover = Sales = $ 300,000/-

6) Return on Investment (ROI) = (Net Operating Income/ Average Operating Assets) * 100 = ($48,000/$200,000) * 100 = 24%

7) If the company pursues the investment and performs the same as the last year, then the company's margin would be $1,192,000/- (Refer Calculation Sheet attached below)

Particulars
Return on Investment of previous Year	A	30%
Investment of previous Year ($)	B	1,000,000.00
Additional Investment for the current year ($)	C	200,000.00
Total Investment	D = B + C	1,200,000.00
Net Operating Income ($1,200,000 * 30%)	E = A * D	360,000.00
Fixed Expenses of Last Year	F	700,000.00
Fixed Expenses Current Year	G	132,000.00
Contribution Margin	H = E + F + G	1,192,000.00

Note

Fixed Expenses of previous year remain the same irrespective of the volume and will be continued to be incurred this year as well

8) If the company pursues the investment, then the total investment would be $1,200,000/-. The Sales/ Turnover last year was 1.5 times (150%) of the investment and if the company performs at the same rate as the last year, the turnover this year would be $1,800,000/- ($ 1,200,000 * 150%)