Problem: Kirsi Products is decentralized. Division bonuses are based on return on investment (ROI), and so division managers are very careful about their ROI. Operating results for the company's East Division for last year are given below when the company's overall ROI was 18%:
Sales $ 25,200,000
Variable expenses 14,000,000
Contribution margin 11,200,000
Fixed expenses 9,158,800
Net operating income $ 2,041,200
Divisional operating assets $ 5,600,000
East Division has an opportunity to add a new product line with an investment of $3,000,000 with the following expected results:
Sales $ 9,300,000
Variable expenses 65% of sales
Fixed expenses $ 2,604,000
Question 1. Compute the East Division's ROI for last year and if the new product line is added.
Question 2. If you were in the East Division's manager, would you accept or reject the new product line?
Question 3. Why do you suppose Krisi Products is anxious for the East Division to add the new product line?
Question 4. Suppose that Krisi Product's minimum required rate of return on operating assets is 15% and that bonuses are based on residual income.
a. Compute the East Division's residual income for last year and after the new product line is added.
b. Under these circumstances, if you were East Division's manager would you accept or reject the new product line?