The Consumer Services Division is one part of Vargas Corporation. For 2014, the

Question

The Consumer Services Division is one part of Vargas Corporation. For 2014, the Consumer Services Division reported income of $121,000 on an investment in operating assets of $800,000. 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 in adding a new series line that would result in the following revenues and costs: 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%. 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% Which performance evaluation measure will more likely motivate the division manager to do what is best for the company is u whole?

Explanation / Answer

1)ROI = 121,000net operating income/ 800,000 average assets = 15.125%

2) ROI = 70,000/ 500,000 = 14%

3) 191,000/ 1,300,000 = 14.69%

4) No since the overall ROI will decrease

5) yes

6) Residual income = 121,000 - (800,000@11%) = $33,000

                                = 191,000 - (1,300,000@11%) = $48,000

7) Residual income is better alternative

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