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 for the new investment of £2,000,000

A)£1,000,000.
B)-£1,000,000
C)-£157,200.
D)-£182,000.

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 for the new investment of £2,000,000

A)£1,000,000.
B)-£1,000,000
C)-£157,200.
D)-£182,000.

Quizplus · Accepted Answer

To calculate residual income, we need to first calculate the net income of the new product line. 
Sales revenue = 420,000 units x £5.20 = £2,184,000 
Variable costs = 420,000 units x £2.86 = £1,201,200 
Fixed costs = £900,000 
Net income = £2,184,000 - £1,201,200 - £900,000 = £82,800

Next, we need to calculate the minimum required return on investment using the following formula: 
Minimum required return = Investment x Required rate of return 
Minimum required return = £2,000,000 x 12% = £240,000

Finally, we can calculate the residual income: 
Residual income = Net income - Minimum required return 
Residual income = £82,800 - £240,000 = -£157,200 
Since the residual income is negative, it means that the actual return on investment is lower than the required return. Therefore, the new product line may not be a good investment choice for the company.

The Managers of Herwhno Want to Introduce a New Product