Case Guidelines:

$$

Cases have no word$-$count requirement. Simply answer the questions for each case.

When using intermediate decimal calculations which require rounding, please use this rule for maximum accuracy of your final answer: intermediate calculations should be rounded to as many decimal places as there are digits in your underlying data. For example, if your data is in the ten millions $(10,000,000)$ you should round intermediate calculations to eight decimal places. If your data is in the ten thousands $(10,000)$ you should round intermediate calculations to $5$ decimal places.

Final answers should be rounded to the nearest cent $($if the answer does not come out as an even dollar amount$).$

$$

The importance of proper rounding using the intermediate calculation rule is illustrated in the following example:

$40,000,000$ X $1/3=?$

$$

If you round $1/3$ to two decimal places, you will get $40,000,000$ X $\mathrm{.}33=13,200,000$

If you round $1/3$ to $8$ decimal places $($per the above rule$),$ you will get $40,000,000$ X $\mathrm{.}33333333=13,333,333$

$$

If you do not round properly, your final answer will be off by $133,333$

$$

$$

Hint: To help you with Requirement $4,$ the formula for residual income is:

$$

RI $=$ Operating Income $-($Minimum Required Rate of Return X Operating Assets$)$

$$

The EVA formula illustrated in the textbook on page $402$ is a refinement of this basic formula. EVA uses after$-$tax income and assumes the minimum required rate of return is the cost of capital. Chapter $11$ Case

"I know headquarters wants us to add that new product line," said Fred Holloway, manager of Kristi Products' West Division. "But I want to see the numbers before I make a move. Our division's return on investment $($ROI$)$ has led the company for three years, and I don't want any letdown."

Kristi Products 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 West Division for the last year are given below:

The company had an overall ROI of $\backslash (18\backslash \%\backslash )$ last year $($considering all divisions$).$ The company's West division has an opportunity to add a new product line that would require an investment of $\backslash (\backslash$$ $3,000,000\backslash ).$ The cost and revenue characteristics of the new product line per year would be as follows:

Sales................................ $\backslash (\backslash$$ $9,000,000\backslash )$

Variable expenses............ $\backslash (65\backslash \%\backslash )$ of sales

Fixed expenses.

$\backslash (\backslash$$ $2,520,000\backslash )$

Required:

$1.(2$ points$)$ Compute the West Division's ROI for last year; also compute the ROI as it would appear if the company duplicated the same performance as last year and also added the new product line.

$2.(2$ points$)$ If you were in Fred Holloway's position, would you accept or reject the new product line? Explain.

$3.(2$ points$)$ Why do you suppose headquarters is anxious for the West Division to add the new product line?

$4.$ Suppose that the company's minimum required rate of return on operating assets is $\backslash (15\backslash \%\backslash )$ and that the performance is evaluated using residual income.

a$.(2$ points$)$ Compute the West Division's residual income for the last year; also compute the residual income as it would appear if the company duplicated the same performance as last year and also added the new product line.

b$.(2$ points$)$ Under these circumstances, if you were in Fred Holloway's position would you accept or reject the new product line? Explain.