Westerville Company reported the following results from last year’s operations:

Question

Westerville Company reported the following results from last year’s operations:

At the beginning of this year, the company has a $200,000 investment opportunity with the following cost and revenue characteristics:

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?

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

Explanation / Answer

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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