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ROI and RI (residual income)

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Fred Halloway, East Division Manager: "I know headquarters wants us to add on that new product line, but I want to see the numbers before I make a move. Our division has led the company for three years, and I don't want any letdown now."
Kirsi Products is a decentralized company with four autonomous divisions. The divisions are evaluated on a basis of the return that they are able to generate on invested assets, with year-end bonuses given to the divisional managers who have the highest ROI figures. Operating results for the company's East Division for last year are given below.

Sales $ 20,000,000
Less variable expenses 13,000,000
Contribution margin 7,000,000
Less fixed expenses 5,500,000
Net operating income $ 1,500,000
Divisional operating assets $ 5,000,000

The company had an overall ROI of 15% last year (considering all divisions) and views a return of 12% on invested assets as being the minimum that any division should earn. The East Division has an opportunity to add a new product line that would require an investment of $3,000,000. The cost and revenue characteristics of the new product line per year would be:

Sales $9,000,000
Variable expenses 65% of sales
Fixed expenses $2,520,000

1. a. Calculate the East Division's ROI for last year. ___________________

b. Recalculate the ROI supposing assuming that the new product line had been
added. ________________

2. Suppose that the performance is evaluated by the residual income (RI) approach.

a. Calculate the East Division's RI for last year. ___________________

b. Recalculate the RI supposing assuming that the new product line had been
added. ________________

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The solution explains how to calculate the ROI and RI