Question

The following information applies to the questions displayed below.] Westerville Company reported the following results from last year’s operations: Sales $ 2,200,000 Variable expenses 660,000 Contribution margin 1,540,000 Fixed expenses 1,100,000 Net operating income $ 440,000 Average operating assets $ 1,375,000 This year, the company has a $275,000 investment opportunity with the following cost and revenue characteristics: Sales $ 440,000 Contribution margin ratio 60 % of sales Fixed expenses $ 220,000 The company’s minimum required rate of return is 15% 4. What is the margin related to this year’s investment opportunity? 5. What is the turnover 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? 8. If the company pursues the investment opportunity and otherwise performs the same as last year, what turnover will it earn this year? 9. If the company pursues the investment opportunity and otherwise performs the same as last year, what ROI will it earn this year? 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? 15-a. Assume that the contribution margin ratio of the investment opportunity was 55% 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?

Answer 1

The margin related to the new investment opportunity is $264,000, and turnover is 0.27. Last year's residual income was $236,250. The CEO must compare the last residual income with that of the new investment to decide whether it is beneficial to pursue.

Step-by-step explanation:

The margin related to this year's investment opportunity is calculated from the contribution margin ratio and sales. The contribution margin ratio is given as 60%, so the margin can be found by multiplying the sales for the investment opportunity by this percentage. The sales are reported as $440,000, so the margin is 0.60 × $440,000 = $264,000.

The turnover is the ratio of sales to average operating assets. In this investment opportunity, the sales are $440,000, and if the investment of $275,000 is the only new asset, then the total average operating assets would be last year's assets plus the investment, so $1,375,000 + $275,000 = $1,650,000. The turnover is then calculated as $440,000 ÷ $1,650,000 = 0.27.

For question 11, last year's residual income is the net operating income minus the product of the minimum required rate of return and the average operating assets. It can be found by using the formula Residual Income = Net Operating Income - (Average Operating Assets × Minimum Required Rate of Return). This results in $440,000 - ($1,375,000 × 15%) = $236,250.

If the CEO's bonus depends on the residual income of the investment opportunity (with a 55% contribution margin ratio instead of 60%), then the margin for the investment would be lower. The new margin would be 0.55 × $440,000 = $242,000. The CEO would calculate the new residual income for the investment and compare it to last year's. If it results in a higher number, then it may be worth pursuing the investment opportunity.