Question

Westerville Company reported the following results from last year’s operations: Sales $1,200,000 Variable expenses 320,000 Contribution margin 880,000 Fixed expenses 640,000 Net operating income $ 228,000 Average operating assets $ 600,000 This year, the company has a $150,000 investment opportunity with the following cost and revenue characteristics: Sales $240,000 Contribution margin ratio 50% of sales Fixed expenses $84,000 What is last year’s margin? What is last year’s turnover? What is last year’s return on investment (ROI)? What is the margin related to this year’s investment opportunity? What is the turnover related to this year’s investment opportunity? What is the ROI related to this year’s investment opportunity? f the company pursues the investment opportunity and otherwise performs the same as last year, what margin will it earn this year? If the company pursues the investment opportunity and otherwise performs the same as last year, what turnover will it earn this year? If the company pursues the investment opportunity and otherwise performs the same as last year, what ROI will it earn this year? 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 Would the owners of the company want her to pursue the investment opportunity? Yes or No What is last year’s residual income? What is the residual income of this year’s investment opportunity? If the company pursues the investment opportunity and otherwise performs the same as last year, what residual income will it earn this year? . 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

Answer 1

Answer:

1) Last years' margin = Net operating income÷ Sales    

                               =  240,000÷1,200,000

                               = 0.2= 20%

2) Last years' turnover = Sales ÷ Average operating assets

                                        = 1,200,000 ÷ 600,000

                                         = 2

3) Last years' return on investment = Margin ratio × turnover ratio

                                                              = 20% × 2 = 40%

4) Margin for this years' investment = Net operating income ÷ Sales

                                                            = 36,000 ÷ 240,000

                                                            = 0.15 = 15%

5) Turnover for this year = Sales ÷ Average operating assets

                                           = 2,400,000 ÷  600,000

                                            = 4

6)  Return on investment for this year =  Margin ratio × turnover ratio

                                                              =  50% × 4 = 200%

7) Since this years' ROI is higher than that of last year, she would pursue the investment opportunity.

8) Yes, the owners of the company would want her to pursue the investment opportunity because of high ROI.

9) This years' residual income = Net operating income - ( required return× Investment)

                                                     = 36000 - ( 200% × 150,000)

                                                      = ( 264,000)

Answer 2

Answer:

Return on investment is the ratio of net income and investment. It is also referred to as the total amount earned by the investment. It is determined by the percentage invested and the fluctuation of the market.

Explanation:

Computation of last year margin:

$\begin{aligned}\text{1) Last years' margin} &= \dfrac{\text{Net operating income}}{\text{Sales}} \\&= \dfrac{240,000}{1,200,000}\\&= 0.2\\&= 20 \% \end{aligned}$

computation of last year turnover:

$\begin{aligned}\text{2) Last years' turnover} &= \dfrac{\text{Sales}} {\text{ Average operating assets}}\\ &= \dfrac{1,200,000}{600,000}\\ &= 2 \end{aligned}$

Computation of last year return on investment:

$\begin{aligned}\\3) \text{Last years' return on investment} &=\dfrac {\text{Margin ratio}}{\text{turnover ratio}} \\&= 20\; \% \times 2 \\&=40 \;\%\end{aligned}$

Computation of margin for this year investment:

$\begin{aligned}\text{4)Margin for this years' investment} &= \dfrac{\text{Net operating income}}{\text{sales}}\\&= \dfrac{36,000}{240,000}\\&= 0.15 \\&= 15\;\%\end{aligned}$

Computation of turnover for this year:

$\begin{aligned} \text{5) Turnover for this year}&=\dfrac{\text{Sales}}{\text{Average operating assets}}\\&=\dfrac{2400000}{600000}\\&=4\end{aligned}$

Computation of return on investment for this year:

$\begin{aligned} \text{6) Return on investment for this year}&=\text{Marginal Ratio} \times {\text{turnover ratio}\\&=50 \% \times 4\\&=200 \%\end{aligned}$

7) She would prefer or pursue the investment opportunities because the rate of interest is higher as compared to last year.

8) Because of the high rate of interest, the owner company pursues investment opportunities.

Computation of the residual income:

9) $\text{This years' residual income}=\text{Net Operating income}-(\text{required return} \times \text{investment}})$

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