Worley Inc. reported the following results from last year's operations:?Sales$13,200,000?Variable expenses8,490,000?Contribution margin4,710,000?Fixed expenses3,654,000?Net operating income$1,056,000?Average operating assets$6,000,000At the beginning of this year, the company has a $1,000,000 investment opportunity with the following characteristics:?Sales$3,400,000 ??Contribution margin ratio50%of sales?Fixed expenses$1,496,000 ?The company's minimum required rate of return is 17%.Required:1. What was last year's residual income?2. If the company pursues the investment opportunity and otherwise performs the same as last year, what will be the overall residual income this year?3. 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 | $1,056,000 |
| ? | Minimum required return ($6,000,000 × 17%) | 1,020,000 |
| ? | Residual income | $60,000 |
2. If the company pursues the investment opportunity, this year's residual income will be:
| ? | The net operating income for this year's investment opportunity is: | |
| ? | Contribution margin (50% × $3,400,000) | $1,700,000 |
| ? | Fixed expenses | 1,496,000 |
| ? | Net operating income | $204,000 |
Net operating income = $1,056,000 + $204,000 = $1,260,000
| ? | Average operating assets | $7,000,000 |
| ? | Net operating income | $1,260,000 |
| ? | Minimum required return ($7,000,000 × 17%) | 1,190,000 |
| ? | Residual income | $70,000 |
3. The CEO would pursue the investment opportunity because residual income would increase by $34,000.
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