Westerville 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%.
13. If the company pursues the investment opportunity and otherwise performs the same as last year, what residual income will it earn this year?
Net income from investment opportunity = (Sales * Contribution margin ratio) - Fixed exp
= ($300,000 * 60 %) - $132,000 = $48,000
Total net income for the company this year
= Last year net income + Net income from investment opportunity
= $300,000 + $48,000 = $348,000
Total average operating assets for the company this year
= Average operating assets last year + (Investment opportunity / 2)
= $1,000,000 + ($200,000 / 2) = $1,100,000
Residual income for the company this year
= Net income - (Minimum required rate of return * Average operating assets)
= $348,000 - (10 % * $1,100,000)
= $238,000
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