Question

The Scarf division of Wintertime Inc. reported the following results from last year’s operations:

Sales	$1,000,000
Variable expenses	700,000
Contribution margin	300,000
Fixed expenses	200,000
Net operating income	$100,000
Average operating assets	$1,000,000

At the beginning of the year the Scarf division had a $200,000 investment opportunity with the following characteristics:

Sales	$300,000
Contribution margin ratio	40%	of sales
Fixed expenses	$60,000

If the division pursues the investment opportunity and otherwise performs the same as last year, the combined (new) ROI for the division will be closest to:

• 20.00%

• 18.33%

• 13.33%

• 9.17%

Answer 1

The right option is 3rd - "13.33%".

Combined (new) ROI for the division = combined net operating income / Combined average investment

Combined net operating income = net operating income as last year's + net operating income with new investment opportunity

Where, net operating income with new investment opportunity = ( Sales * contribution margin ratio ) - fixed expenses = ( $300,000 * 40% ) - $60,000 = $60,000

Combined net operating income = net operating income as last year's + net operating income with new investment opportunity = $100,000 + $60,000 = $160,000

Combined average investment = average operating assets as last year + investment in new opportunity = $1,000,000 + $200,000 = $1,200,000

Combined (new) ROI for the division = combined net operating income / Combined average investment = $160,000 / $1,200,000 = 13.33%