Question

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

Sales	$	1,300,000
Variable expenses		440,000
Contribution margin		860,000
Fixed expenses		600,000
Net operating income	$	260,000
Average operating assets	$	812,500

At the beginning of this year, the company has a $162,500 investment opportunity with the following cost and revenue characteristics:

Sales	$	260,000
Contribution margin ratio		80	% of sales
Fixed expenses	$	182,000

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

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 or No

10-b. Would the owners of the company want her to pursue the investment opportunity?

   Yes or No

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?

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?

   Yes or No

15-a. Assume that the contribution margin ratio of the investment opportunity was 75% instead of 80%. 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 or No

15-b. Would the owners of the company want her to pursue the investment opportunity?

   Yes or No

Answer 1

		Last Year Performance		Current	Total
		Amnt$	Amnt$	Amnt$	Amnt$
	Sales==A		13,00,000	2,60,000	15,60,000
	Less
	Variable Expenses		4,40,000	52,000	4,92,000
	Contribution margin		8,60,000	2,08,000	10,68,000	(80% on Revenue =$260000)
	Less
	Fixed cost		6,00,000	1,82,000	7,82,000
	Net Operating Income=D		2,60,000	26,000	2,86,000
	Average Operating Asset=E		8,12,500	1,62,500	9,75,000
	KPI
	Net Margin (D/A)		20.00%	10.00%	18.33%
	Asset Turnover(A/E)
	( net Sales/ Avg Asset)		1.60	1.60	1.60
	ROI
	( NET Margin *Asset Turnover)		32.00%	16.00%	29.33%
	(20%*1.60)
Answer 10a
	Westerville CEO will earn Bonus ONLY if current Year ROI exceed last year ROI
	Current year ROI is quite low ( 16%) as compared with LY ROI ( 32%)
	NOT eligible for Bonus
Answer 10b
	Company minimum required rate of Retun 15% . Where as company at present as well as combined
	level cross minimum Return So GO FOR Investment= YES
Answer 11
	Last year Residual Income
	Operating Profit $		2,60,000
	Minimum required return		15%
	Average Operating Asset$		8,12,500
	Operating Profit $- ( Min Required return *Avg operating Asset)
	$260000-(15%*$812500)
	Last year Residual Income $		1,38,125
	$260000-(15%*$812500)
Answer 12
	Current year Residual Income
	Operating Profit $		26,000
	Minimum required return		15%
	Average Operating Asset$		1,62,500
	Operating Profit $- ( Min Required return *Avg operating Asset)
	Current year Residual Income $		1,625
	$26000-(15%*$162500)
	Combined Residual Income
	Operating Profit $		2,86,000
	Minimum required return		15%
	Average Operating Asset$		9,75,000
	Operating Profit $- ( Min Required return *Avg operating Asset)
	Combined year Residual Income $		1,39,750
	$286000-(15%*$975000)

Answer 14	NO she will not Pursue because current Year residual income
	much lower than Earlier Year Residual income
Answer 15	NO she will not Pursue because current Year residual income
	much lower than Earlier Year Residual income
	After change Contribution Margin ratio 75% . She will
	end up current month with NEGATIVE residual Income