Required information The Foundational 15 [LO11-1, LO11-2] The tollowing informat
ID: 2526841 • Letter: R
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Required information The Foundational 15 [LO11-1, LO11-2] The tollowing information applies to the questions displayed below. Westerville Company reported the following results from last year's operations Sales Variable expenses Contribution margin Fixed expenses $ 1,500,000 730,000 770,000 470,000 $ 300,000 Net operating income Average operating assets937,500 At the beginning of this year, the company has a $362,500 investment opportunity with the following cost and revenue characteristics Sales Contribution margin ratio Fixed expenses $ 580,000 70 % of sales $ 319,000 | ne company's minimum required rate of return is 10%Explanation / Answer
Solution 11:
Last year residual income = Net operating income - Minimum required return
= $300,000 - ($937,500* 10%) = $206,250
Solution 12:
Operating income from investment opportunity = contribution - Fixed expenses = ($580,000*70%) - $319,000 = $87,000
Investment in new opportunity = $362,500
Residual income of new investment opportunity = Net operating income - Minimum required return
= $87,000 - ($362,500* 10%) = $50,750
Solution 13:
Total operating income for current year = Last year operating income + Operating income of new investment opportunity
= $300,000 + $87,000 = $387,000
Average operating assets = $937,500 + $362,500 = $1,300,000
Residual income for current year = $387,000 - ($1,300,000*10%) = $257,000
Solution 14:
As residual income is increasing current year due to new investment opportunity, therefore CEO should pursue new investment opportunity.
Solution 15a:
If contribution margin ration for new investment opportunity is 60%, then
Net operating income for new investment opportunity = ($580,000*60%) - $319,000 = $29,000
Total operating income for current year = $300,000 + $29,000 = $329,000
residual income = $329,000 - $130,000 = $199,000
As residual income is reduced from $206,250 to $199,000, therefore CEO should not pursue new investment opportunity.
Solution 15b:
Yes, owner want her to pursue the new investment opportunity because there is net operating income of $29,000 from new investment opportunity and it will increase operating income of the company
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