The Major Operating Divisions of Grey Company Are Organized as Investment

question 42

Essay

The major operating divisions of Grey Company are organized as investment centers for performance evaluation purposes. The division managers are evaluated, in part, on the basis of the change in the return on investment (ROI) of their units. Operating results for the Division A for the coming year, 2019, based on its existing assets are budgeted as follows:
$$\begin{array} { | l | r | } \hline \text { Sales } & \$ 5,000,000 \\\hline \text { Less variable costs } & \underline { 2,500,000 } \\\hline \text { Contribution margin } & 2,500,000 \\\hline \text { Less fixed expenses } & \underline { 1,800,000 } \\\hline \text { Operating income } & \$ 700,000 \\\hline\end{array}$$ Operating assets for the Division A are currently $3,600,000. For 2019, the division can add a new product line for an investment of $600,000. The new product line is expected to generate sales of $1,600,000 and will incur fixed expenses of $600,000 annually. Variable costs of the new product are expected to average 60% of the selling price.
Required:
1. What is the effect on ROI of accepting the new product line?
2. If the company's required rate of return is 6% and residual income is used to evaluate managers, would this encourage the division to accept the new product line? Explain and show computations.

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Definitions:

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The process of removing substances such as fluids or gases by creating a vacuum.

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A respiratory therapy that encourages voluntary deep breathing by visual feedback to improve lung function.

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Measures taken to prevent choking and ensure safe ingestion of food and liquids, especially in individuals with difficulty swallowing.

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