Question

[The following information applies to the questions displayed below.] Westerville Company reported the following results from last year’s operations: Sales $ 1,750,000 Variable expenses 520,000 Contribution margin 1,230,000 Fixed expenses 880,000 Net operating income $ 350,000 Average operating assets $ 875,000 This year, the company has a $200,000 investment opportunity with the following cost and revenue characteristics: Sales $ 320,000 Contribution margin ratio 60 % of sales Fixed expenses $ 128,000 The company’s minimum required rate of return is 20%.

1. What is last year’s margin?

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?

5. What is the turnover related to this year’s investment opportunity? (Round your answer to 1 decimal place.)

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-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? No Yes

Answer 1

SOLUTION

1. Last year's margin -

Margin = Net operating income / Sales

= $350,000 / $1,750,000

= 20%

2. Last year's turnover-

Turnover = Sales / Average operating assets

= $1,750,000 / $875,000

= 2.0

3. Last year’s return on investment (ROI) -

ROI = Margin * Turnover

= 20% * 2

= 40%

4. The margin for this year’s investment opportunity -

Margin = Net operating income / Sales

= $64,000 / $320,000

= 20%

Contribution margin = $320,000 * 60% = $192,000

Net operation income = Contribution margin - Fixed expense

= $192,000 - $128,000 = $64,000