(SO 4, 5)

Compare ROI and residual income with supporting calculations.

South division had the following results for the year just ended:Sales $1,500,000

Controllable margin $120,000

Contribution margin 600,000

Average operating assets 600,000

South is considering a new product line that would involve the following:

Sale s$300,000

Controllable margin $24,000

Contribution margin 120,000

Average operating assets 150,000

South’s parent company, Globe Inc., has a company-wide ROI of 14% and pays bonuses based on divisional ROI.

Instructions

(a)  Determine the effect on South’s ROI if it introduces the new product line. Would South’s managers be encouraged to introduce the new product line?

(b)  Determine the effect on Globe Inc.’s ROI if South introduces the new product line. Would the top managers of Globe Inc. want to introduce the new product line?

ROI of new product: 16%

(c)  Assume a required rate of return of 10% on operational assets invested in each division. Determine the effect on South’s residual income if it introduces the new product. Would South’s managers be encouraged to introduce the new product line?