Question

Malibu Corporation is a decentralized wholesaler with four autonomous divisions. The divisions are evaluated on the basis of ROI, with year-end bonuses given to divisional managers who have the highest ROI. Operating results for the Company’s Surf Division for last year are given below:

Sales	$21,000,000
Variable Expenses	$13,400,000
Contribution Margin	$ 7,600,000
Fixed Expenses	$ 5,920,000
Net Operating Income	$ 1,680,000
Divisional operating assets	$ 5,250,000

The company had an overall ROI of 18% last year (considering all divisions). The company’s Surf 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 as follows:

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

1. What was the Surf Division’s ROI for last year?

2. What is the projected ROI of the new product line?

3. Assuming that that the Surf Division has the same operating results as last year, what would be their projected ROI including the new product line?

4. Based on your ROI analysis, should the Surf Division manager add the new product line?

5. Malibu Corp. has decided to switch to using a residual income measure with a 15% minimum required rate of return. What was the Surf Division’s residual income last year?

6. What is the projected residual income of the new product line?

7. Assuming that that the Surf Division has the same operating results as last year, what would be their projected residual including the new product line?

8. Based on your residual income analysis, should Surf Division manager add the new product line?

Answer 1

ans 1
Surf division ROI
ROI=net operating Income/Divisional operating assets
1680000/5250000*100	32.0	%
ans 2
Projected ROI of new product line	21	%
630000/3000000*100
Sales	$9,000,000
Variable Expenses	$5,850,000
Fixed Expenses	$2,520,000
Net operating Income	$630,000
ans 3
ROI=(1680000+630000)/(5250000+3000000)*100	28	%
ans 4
No it should not add the product line as it will decrease the
ROI of surf division.
ans 5
Surf division
Net operating Income N	$1,680,000
Avg operating assets A	5250000
Min req rate M	15%
Min required amt R=A*M	787500
Residual Income N-R	$892,500
ans 6
New product line
Net operating Income N	$630,000
Avg operating assets A	3000000
Min req rate M	15%
Min required amt R=A*M	450000
Residual Income N-R	$180,000
ans 7
Net operating Income N	$2,310,000
Avg operating assets A	$8,250,000
Min req rate M	15%
Min required amt R=A*M	1237500
Residual Income N-R	$1,072,500
ans 8
Yes the residual income analysis the new product line