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

Question

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

Sales

$

1,800,000    

Variable expenses

435,000    

Contribution margin

1,365,000    

Fixed expenses

1,005,000    

Net operating income

$

360,000    

Average operating assets

$

1,200,000    

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

  Sales

$

360,000

  Contribution margin ratio

70

% of sales

  Fixed expenses

$

216,000

The company’s minimum required rate of return is 10%.

5. What is the turnover related to this year’s investment opportunity? (Round your answer to 1 decimal place.

6. What is the ROI related to this year’s investment opportunity?

7. If the company pursues the investment opportunity and otherwise performs the same as last year, what margin will it earn this year? (Round your percentage answer to 1 decimal place (i.e .1234 should be entered as 12.3))

8. If the company pursues the investment opportunity and otherwise performs the same as last year, what turnover will it earn this year? (Round your answer to 2 decimal places.

9. If the company pursues the investment opportunity and otherwise performs the same as last year, what ROI will it earn this year? (Round your percentage answer to 1 decimal place (i.e .1234 should be entered as 12.3))

10A. 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/NO

10B. Would the owners of the company want her to pursue the investment opportunity? YES/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/NO

15A. Assume that the contribution margin ratio of the investment opportunity was 65% instead of 70%. 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/NO

15B. Would the owners of the company want her to pursue the investment opportunity? YES/NO

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

Sales

$

1,800,000    

Variable expenses

435,000    

Contribution margin

1,365,000    

Fixed expenses

1,005,000    

Net operating income

$

360,000    

Average operating assets

$

1,200,000    

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

  Sales

$

360,000

  Contribution margin ratio

70

% of sales

  Fixed expenses

$

216,000

The company’s minimum required rate of return is 10%.

Explanation / Answer

(5) Turnover = Sales / Investment

= $360,000 / $300,000 = 1.2

(6) ROI = Net income / Investment

Net income ($) = Contribution - Fixed cost = (360,000 x 0.7) - 216,000 = 252,000 - 216,000 = 36,000

ROI = $36,000 / $300,000 = 0.12, or 12%

(7) Margin = Net income / Sales

Overall Sales ($) = 1,800,000 + 360,000 = 2,160,000

Overall net income ($) = 360,000 + 36,000** = 396,000

**See last question

Margin = $396,000 / $2,160,000 = 0.183, or 18.3%

(8)

Overall investment ($) = 1,200,000 + 300,000 = 1,500,000

Turnover = $2,160,000 / $1,500,000 = 1.44

(9)

ROI = $396,000 / $1,500,000 = 0.264, or 26.4%

Note: First 5 questions are answered.

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