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Problem 12.61

Kitchen Appliances Inc. is a multi-division company with each major product-line managed by a separate division. Divisional managers have complete autonomy with respect to operating and investment decisions. The company evaluates its division managers on ROI, calculated as operating income before taxes (for that year) divided by net book value of assets (at the beginning of that year). The firm pays particular attention to year-over-year growth in ROI as well as budget-actual comparison of the measure.

Wendy Miller is the manager of the dishwasher division. Wendy expects that the operating income for the current year will be $2,400,000 before taxes. Given a net asset base of $6,800,000, the division’s ROI would be a healthy 35 percent, well above the average return from other divisions. This performance has been fairly representative of the way things have been going for Wendy. She expects a similar performance next year as well, and is looking forward to her promotion into the C-suite (the corporate office).

Toward the end of the current year, an investment opportunity arises for Wendy – the possibility of introducing a new dishwasher model with improved features. The following table presents some salient financial information that Wendy’s managers put together for her evaluation:

|Incremental cash outlay for additional equipment |$1,500,000 |
|Useful life |10 years |
|Salvage value at the end of useful life |0 |
|Annual revenues |800,000 |
|Annual variable costs |300,000 |
|Annual fixed costs (excluding depreciation) |100,000

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