Question

Westerville Company reported the following results from last year's operations Sales Variable expenses Contribution margin Fixed expenses Net operating income $1,500,000 690,000 810,000 435,000 $375,000 Average operating assets $ 1,250,000 At the beginning of this year, the company has a $350,000 investment opportunity with the following cost and revenue characteristics Sales Contribution margin ratio Fixed expenses $420,000 70% of sales 252,000 The company's minimum required rate of return is 10%.

Be sure to show your steps and explain why! Or I will rate it as incomplete.

Answer 1

Solution 14:

Residual Income of last year = Net Operating Income - minimum required return = $375000 - ($1250000*10%) = $250,000

Operating income from Investment opportunity = $420000*70% - $252000 = $42,000

Residual Income of This year = Total Net Operating Income - Total minimum required return

= ($375000+$42000) - [($1250000+$350000)*10%)] = $417000 - $160000 = $257,000

Increase in residual income = $257000 - $250000 = $7,000

Hence,

Yes, she should pursue the investment opportunity as Residual income this year is higher than last year.

Solution 15-a:

Operating income from Investment opportunity = $420000*65% - $252000 = $21,000

Residual Income of This year = Total Net Operating Income - Total minimum required return

= ($375000+$21000) - [($1250000+$350000)*10%)] = $396000- $160000 = $236,000

Decrease in residual income = $236000 - $250000 = $14,000

Hence,

No, she should not pursue the investment opportunity as Residual income this year is lower than last year.

Solution 15-b:

No, owners of company would not want her to pursue the investment opportunity.