Problem - RCI, inc is a decentralized organization with four autonomous divisions. The divisions are evaluated on the basis of the change in their return on invested assets. Operating results in the Commercial Division for the 2012 follow:
RCI Inc.-Commercial Division Income Statement For Year Ending December 31, 2012
Sales.....$3,125,000
Less variable expense.....(1,600,000)
Contribution margin.....1,525,000
Less fixed expenses.....(1,000,000)
Net Operating Income.....$525,000
Operating assets for the Commercial Division currently average $2,500,000. The commercial division can add a new product line for an investment of $300,000. Relevant data for the new product line are as follows:
Sales...$800,000
Variable expenses (% of sales).....0.60
Fixed expenses....$275,000
Increase in current liabilities....$20,000
REQUIRED
a. Determine the effect on ROI of accepting the new product line. (Round calculations to three decimal places).
b. If a return of 6% is the minimum that any division should earn and residual income is used to evaluate managers, would this encourage the division to accept the new product line? Explain and show computations.
c. If EVA is used to evaluate managers, should the new product line be accepted if the weighted average cost of capital is 8% and the income tax rate is 40%?