Review Problem

The Magnetic Imaging Division of Medical Diagnostics, Inc., has reported the following
results for last year’s operations:

Sales $25 million

Net operating income $3 million

Average operating assets $10 million

Required: 1. Compute the Magnetic Imaging Division’s margin, turnover, and ROI.

2. Top management of Medical Diagnostics, Inc., has set a minimum required rate of return
on average operating assets of 25%. What is the Magnetic Imaging Division’s residual
income for the year?

Review questions

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 assets 625,000
This year, the company has a $120,000 investment opportunity with the following cost and
revenue characteristics:
Sales $200,000
Contribution margin ratio 60% of sales
Fixed expenses $90,000
The company’s minimum required rate of return is 15%.
Required: 1. What is last year’s margin?

2. What is last year’s turnover?

3. What is last year’s return on investment (ROI)?

4. What is the margin related to this year’s investment opportunity?

5. What is the turnover related to this year’s investment opportunity?

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?

8. If the company pursues the investment opportunity and otherwise performs the same as
last year, what turnover will it earn this year?

9. If the company pursues the investment opportunity and otherwise performs the same as
last year, what ROI will it earn this year?

10. 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? Would the
owners of the company want her to pursue the investment opportunity?

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?

15. Assume that the contribution margin ratio of the investment opportunity was 50%
instead of 60%. 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? Would the owners of the company want her to pursue the
investment opportunity?