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

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%.

1. What is last year's margin?

2. What is last year’s turnover? (Round your answer to 1 decimal place.)

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

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?

	Yes
	No

15-b.

Would the owners of the company want her to pursue the investment opportunity?

	Yes
	No

Answer 1

Answer of Part 1:

Margin = Net Operating Income / Sales
Margin = $180,000 / $1,200,000
Margin = 0.15 or 15%

Answer of Part 2:

Turnover = Sales / Average Operating Assets
Turnover = $1,200,000 / $600,000
Turnover = 2

Answer of Part 3:

Return on Investment = Margin * Turnover
Return on Investment = 15% * 2
Return on Investment = 30%

Answer of Part 4:

Contribution Margin = Sales * 60%
Contribution Margin = $220,000 * 60%
Contribution Margin = $132,000

Net Operating Income = Contribution Margin – Fixed Assets
Net Operating Income = $132,000 - $99,000
Net Operating Income = $33,000

Margin = Net Operating Income / Sales
Margin = $33,000 / $220,000
Margin =0.15 or 15%