The managers of Herwhno want to introduce a new product line. The financial performance of the company for the most recent year is given below:$$\begin{array} { | l | l | }
\hline \text { Sales } & £ 63,300,000 \
\hline \text { Less variable costs } & £ 36,720,000 \
\hline \text { Contribution } & £ 26,580,000 \
\hline \text { Less fued expenses } & £ 22,720,000 \
\hline \text { Net profit } & £ 3,860,000 \
\hline \text { Divisional capital employed } & \$ 23,200,000 \
\hline
\end{array}$$
The company estimates that the required return on investment should be a minimum of 12%.
Details of new product line
The sales manager estimates that sales for the new product will be 420,000 units per annum if the selling price is £5.20 per unit. Variable costs are estimated to be £2.86 per unit. Fixed costs will increase by £900,000.
A budget of £2,000,000 has been agreed for investment in new machinery.
-Calculate the Residual Income after the new investment is accepted

A)£918,800.
B)B.-£918,000.
C)£1,100,000.
D)£2,140,000.

Question

The managers of Herwhno want to introduce a new product line. The financial performance of the company for the most recent year is given below:$$\begin{array} { | l | l | } 
\hline \text { Sales } & £ 63,300,000 \
\hline \text { Less variable costs } & £ 36,720,000 \
\hline \text { Contribution } & £ 26,580,000 \
\hline \text { Less fued expenses } & £ 22,720,000 \
\hline \text { Net profit } & £ 3,860,000 \
\hline \text { Divisional capital employed } & \$ 23,200,000 \
\hline
\end{array}$$
The company estimates that the required return on investment should be a minimum of 12%.
Details of new product line
The sales manager estimates that sales for the new product will be 420,000 units per annum if the selling price is £5.20 per unit. Variable costs are estimated to be £2.86 per unit. Fixed costs will increase by £900,000.
A budget of £2,000,000 has been agreed for investment in new machinery. 
-Calculate the Residual Income after the new investment is accepted

A)£918,800.
B)B.-£918,000.
C)£1,100,000.
D)£2,140,000.

Quizplus · Accepted Answer

To calculate the Residual Income, we need to deduct the minimum required return on investment from the profit generated by the new product line.

First, let's calculate the profit generated by the new product line:

Sales revenue = 420,000 units x £5.20 = £2,184,000
Variable costs = 420,000 units x £2.86 = £1,200,600
Fixed costs = £900,000
Total costs = £2,100,600
Profit = £2,184,000 - £2,100,600 = £83,400

Next, let's calculate the minimum required return on investment:

Minimum required return = 12% x £2,000,000 = £240,000

Finally, we can calculate the Residual Income:

Residual Income = Profit - Minimum required return
Residual Income = £83,400 - £240,000
Residual Income = -£156,600

Since the Residual Income is negative, it means that the new investment in the product line will not meet the minimum required return on investment of 12%. Therefore, the best choice is A, which is the Residual Income in pounds that meets the minimum required return.

The Managers of Herwhno Want to Introduce a New Product