Division bonuses are based on return on investment (ROI)

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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

Compute the East Division’s ROI for last year and if the new product line is added.

2. If you were in the East Division’s manager, would you accept or reject the new product line?

3. Why do you suppose Krisi Products is anxious for the East Division to add the new product line?

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?

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