The consumer Services Division is one part of Vargas Corporation. For 2014, the
ID: 2500716 • Letter: T
Question
The consumer Services Division is one part of Vargas Corporation. For 2014, the Consumer Services Division reported income of 121,000 dollars on an investment in operating assets of 800,000 dollars. The division expects this level of performance to continue for 2015. Senior management of Vargas Corporation has asked the Consumer Services Division to consider investing average operating assets of 500,000 dollars in adding a new service line that would result in the following revenues and costs: Required: Compute the Return On Investment for the Consumer Services Division without the new product line. Compute the Return On Investment that would be generated solely by the new product line. Compute the Return On Investment for the Consumer Services Division with the new product line. Will the Consumer Services Division likely add the new product line given the company's use of ROI as a performance measure? Why or why not? Would the new product line benefit the company as a whole? The required rate of return for the company as a whole is 10 percent. Compute the Consumer Services Division's residual income both without and with the new product line. The required rate of return for the Division is 11 percent. Which performance evaluation measure will more likely motivate the division manager to do what is best for the company as a whole?Explanation / Answer
1) Return on investment for the consumer services division without the new product line.:-
= Return / investment * 100
= 121000 / 800000 * 100
= 15.125 %
2) Return on investment that would be generated solely by the new product line:-
Return on investment = Return / Investment * 100
Return = Net income = Sales - Variable costs - Fixed costs
= 420000 - 110000 - 240000
= $ 70000
Investment in new product line = $ 500000
Accordingly, return on investment that would be generated solely by the new product line:-
= 70000 / 500000 * 100
= 14 %
3) Return on investment for the consumer service division with the new product line:-
Total Return = 121000 + 70000 = $ 191000
Total investment = 800000 + 500000 = $ 1300000
Accordingly, return on investment for the consumer service division with the new product line:-
= 191000 / 1300000 * 100
= 14.69 % (approx)
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