Cinder Corporation operates in a decentralized environment with several operatin

Question

Cinder Corporation operates in a decentralized environment with several operating divisions whose managers are evaluated on the basis of Return on Investment (ROI). The company requires a 10% rate of return. Operating data for the company’s Waterhole division for the year is as follows: Sales $500,000 Average operating assets $400,000 Variable costs $280,000 Fixed costs $100,000 Interest and taxes $15,000 Residual income $80,000 Suppose the Waterhole division manager has an opportunity to add a product line that will generate $50,000 in operating income and will only require an additional investment of $200,000. Will the division likely add the new product line?

a. No. The division’s new ROI measure will be lower than it is now.

b. No. The division’s new ROI will be lower than the required ROI.

c. Yes. The division’s new ROI measure will still far exceed the 10% required ROI.

d. Yes. The new product will add $30,000 in residual income to the division’s existing residual income.

Explanation / Answer

In order to determine whether the division will add the new product line or not, ROI from the new product will have to be computed first. If the ROI of the new product line is higher than or equal to the ROI of the company rthat is 10%, then the division will add the new product line. However, if the ROI of the new product line is less than 10% the division will not add the new product line.

Operating income from the new product line = $50,000

Additional investment in the new product line = $200,000

Therefore,

ROI of the new prodct line = $50,000 / $200,000 = 25%

The ROI of the new product line is much higher than that of the company. Therefore, the division will add the new product line.

The correct answer is c.

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