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

Question

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

Sales $ 1,400,000

Variable expenses 680,000

Contribution margin 720,000

Fixed expenses 440,000

Net operating income $ 280,000

Average operating assets $ 875,000

This year, the company has a $300,000 investment opportunity with the following cost and revenue characteristics:

Sales $ 480,000

Contribution margin ratio 80 % of sales

Fixed expenses $ 336,000

The company’s minimum required rate of return is 15%.

Needed

1. If the company pursues the investment opportunity and otherwise performs the same as last year, what margin will it earn this year?

2. If the company pursues the investment opportunity and otherwise performs the same as last year, what turnover will it earn this year?

3. If the company pursues the investment opportunity and otherwise performs the same as last year, what ROI will it earn this year?

4. What is last year’s residual income?

5. What is the residual income of this year’s investment opportunity?

6. If the company pursues the investment opportunity and otherwise performs the same as last year, what residual income will it earn this year?

Explanation / Answer

Westerville Company All Amounts in $ 2. If the Company pursues the investment opportunity and other things remaining constant Revised Sales = $ 1,400,000 + $ 480,000 = $ 1,880,000 1. Revised Contribution Margin Existing Contribution Margin = $ 720,000 Contribution Margin on investment opportunity is 80% of Sales = 80% of $ 480,000 = $ 384,000 Total Contribution Margin = $ 720,000 + $ 384,000 = $ 1,104,000 3. If the Company pursues the investment opportunity and other things remaining constant Revised Net Operating Income of the Company = $ 1,104,000 - $ 440,000 - $ 336,000 = $ 328,000 Investment (including existing Operating Assets) = $ 1,175,000 ROI for this year = $ 328,000 / $ 1,175,000 = 27.9% 4. Residual Income for last year = $ 280,000 - ($ 875,000 X 15%) = 148750 $ 5. Pure Residual Income from the investment opportunity only = ($ 384,000 - $ 336,000) - ($ 300,000 X 15%) = 3000 $ 6. Residual Income for the current year, after investment opportunity = $ 328,000 - ($ 1,175,000 X 15%) = 151750 $

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