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Westerville Company reported the following results from last year’s operations:   Sales $ 1,000,000   Variable expenses 300,000     Contribution margin 700,000     Fixed expenses 500,000     Net operating income $ 200,000     Average operating...

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Accounting

Westerville Company reported the following results from lastyear’s operations:


  Sales$1,000,000
  Variable expenses300,000  
  Contribution margin700,000  
  Fixed expenses500,000  
  Net operating income$200,000  
  Average operating assets$625,000  


This year, the company has a $120,000 investment opportunitywith the following cost and revenue characteristics:


  Sales$200,000
  Contribution margin ratio60% of sales
  Fixed expenses$90,000
The company’s minimum required rate of return is15%.

13.

If the company pursues the investment opportunity and otherwiseperforms the same as last year, what residual income will it earnthis year?

Answer & Explanation Solved by verified expert
4.1 Ratings (763 Votes)

Residual income=Net operating income-(Minimum required return*Average operating asset)

The new investment opportunity brings additional sales and cost and net income from such investment is calculated below:

Net oeprating income from additional investment=Contribution margin-Fixed expense

=(Additional Sales*Contribution margin ratio)-Fixed expense

=($200,000*60%)-$90,000

=$120,000-$90,000

Additional Net operating income=$30,000

Total Net operating income after adding net oeprating income as per previous year which is same in current year is calculated as below:

Net operating income=$200,000+$30,000

Net oeprating income=$230,000

Average operating assets is changed with this investment made of $120,000, so average operating assets is calculated as below

Average oeprating assets=$625,000+$120,000

Average oeprating assets=$745,000

Residual income=$230,000-($745,000*15%)

=$230,000-$111,750

Residual income=$118,250
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