Willing Inc. reported the following results from last year's operations:?Sales$11,400,000?Variable expenses8,540,000?Contribution margin2,860,000?Fixed expenses1,948,000?Net operating income$912,000?Average operating assets$6,000,000At the beginning of this year, the company has a $1,200,000 investment opportunity with the following characteristics:?Sales$2,400,000??Contribution margin ratio40%of sales?Fixed expenses$744,000?The company's minimum required rate of return is 14%.Required:1. What was last year's residual income?2. What is the residual income of this year's investment opportunity?3. If the company pursues the investment opportunity and otherwise performs the same as last year, what will be the overall residual income this year?4. If Westerville's CEO
earns a bonus only if residual income for this year exceeds residual income for last year, would the CEO pursue the investment opportunity?
What will be an ideal response?
1. Last year's residual income was:
| ? | Average operating assets | $6,000,000 |
| ? | Net operating income | $912,000 |
| ? | Minimum required return ($6,000,000 × 14%) | 840,000 |
| ? | Residual income | $72,000 |
2. The residual income for this year's investment opportunity is:
| ? | Contribution margin (40% × $2,400,000) | $960,000 |
| ? | Fixed expenses | 744,000 |
| ? | Net operating income | $216,000 |
| ? | Average operating assets | $1,200,000 |
| ? | Net operating income | $216,000 |
| ? | Minimum required return ($1,200,000 × 14%) | 168,000 |
| ? | Residual income | $48,000 |
3. If the company pursues the investment opportunity, this year's residual income will be:
Average operating assets = $6,000,000 + $1,200,000 = $7,200,000
Net operating income = $912,000 + $216,000 = $1,128,000
| ? | Average operating assets | $7,200,000 |
| ? | Net operating income | $1,128,000 |
| ? | Minimum required return ($7,200,000 × 14%) | 1,008,000 |
| ? | Residual income | $120,000 |
4. The CEO would pursue the investment opportunity because residual income would increase by $48,000.
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