Question

Westerville Company reported the following results from last year’s operations: Sales $ 1,200,000 Variable expenses 420,000 Contribution margin 780,000 Fixed expenses 600,000 Net operating income $ 180,000 Average operating assets $ 600,000 ________________________________________ At the beginning of this year, the company has a $137,500 investment opportunity with the following cost and revenue characteristics: Sales $ 220,000 Contribution margin ratio 60 % of sales Fixed expenses $ 99,000 The company’s minimum required rate of return is 20%.

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

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?

• Yes
• No

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?

• Yes
• No

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

• Yes
• No

Answer 1

Here multiple subparts posted an i am solving first 4

ROI last year= Net operating income/Average operating assets

=180000/600000=30%

This year ROI is

Net operating income=contribution margin-fixed expenses

=(60%*220000)-99000=33000

Average operating assets=137500

ROI from owner point of view=33000/137500=24%

Total net operating income=180000+33000=213000

Total average operating assets=600000+137500=737500

ROI=213000/737500=28.88%

10a)No since the ROI comes down from 30% to 28.8%

10b)Yes since the ROI of 24% is higher than required minimum return of 20%

11) Residual income=net operating income-(Average operating assets*minimum required return)

=180000-(600000*20%)=60000

12) Residual income=net operating income-(Average operating assets*minimum required return)

=33000-(137500*20%)=5500