\"I know headquarters wants us to add that new product line,\" said Fred Hallowa
ID: 2453121 • Letter: #
Question
"I know headquarters wants us to add that new product line," said Fred Halloway, manager of Kirsi Products' East Division. "But I want to see the numbers before I make a move. Our division's return on investment (ROl) has led the company for three years, and I don't want any letdown." Kirsi Products is a decentralized wholesaler with four autonomous divisions. The divisions are evaluated on the basis of ROl, with year-end bonuses given to divisional managers who have the highest RO Operating results for the company's East Division for last year are given below: Sales $ 21,902,000 Variable expenses 13,788,600 Contribution margin 8,113,400 Fixed expenses Net operating income Divisional operating asset 6,055,000 $ 2,058,400 $ 4,562,500 The company had an overall ROI of 17.50% last year (considering all divisions). The company's East Division has an opportunity to add a new product line that would require an investment of $2,250,500. The cost and revenue characteristics of the new product line per year would be as follows: Sales Variable expenses Fixed expenses $9,450,000 65% of sales $2,570,200Explanation / Answer
Calculation of East Division Residual Income Present New Line Total Operating Assets (A) $4,562,500 $2,250,500 $6,813,000 Minimum Required Rate of Return (B) 14% 14% 14% Minimum Net operating Income (C =A X B) $638,750 $315,070 $953,820 Actual Net Operating Income (D) $2,058,400 $737,300 $2,795,700 Minimum Net operating Income (C) $638,750 $315,070 $953,820 Residual Income (D-C) $1,419,650 $422,230 $1,841,880 Working Notes Calculation of Actual Operating profit of New product Line Sales $9,450,000 Variable Expenses (65% of sales) $6,142,500 Contribution $3,307,500 Less: Fixed Expenses $2,570,200 Net Opearting Income $737,300
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