“I know headquarters wants us to add that new product line,” said Fred Halloway,
ID: 2358250 • Letter: #
Question
“I know headquarters wants us to add that new product line,” said Fred Halloway, manager of Kirsi Products’ East 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.”Kirsi 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 East Division for last year are given below:
Sales $ 23,600,000
Variable expenses 13,000,000
Contribution margin 10,600,000
Fixed expenses 8,594,000
Net operating income $ 2,006,000
Divisional operating assets $ 5,900,000
The company had an overall ROI of 18% last year (considering all divisions). The company’s East Division has an opportunity to add a new product line that would require an investment of $2,980,000. The cost and revenue characteristics of the new product line per year would be as follows:
Sales $ 8,940,000
Variable expenses 65% of sales
Fixed expenses $ 2,521,080
1.
Compute the East Division’s ROI for last year; also compute the ROI as it would appear if the new product line is added. (Round your intermediate calculations and final answers to 2 decimal places. Omit the "%" sign in your response.)
ROI
Present %
New product line alone %
Total % Suppose that the company’s minimum required rate of return on operating assets is 15% and that performance is evaluated using residual income.
a. Compute the East Division’s residual income for last year; also compute the residual income as it would appear if the new product line is added. (Omit the "$" sign in your response.)
Residual income
Present $
New product line alone $
Total $
Explanation / Answer
1. ROI = NOPAT/ Invested Capital ROI(For new Porduct line) Calculation of NOPAT: Sales = Fixed expenses + Variable expenses + NOPAT 8,940,000 = 2,251,080 + 0.65*8,940,000 + NOPAT NOPAT = 8,940,000 - 8,062,080 = 877,920 Invested capital is 2,980,000 ROI = 877,920/2,980,000 = 0.294 ROI is 29.4%. For New product line alone. Calculation of ROI Present: 0.18 = $2,006,000/Invested capital Invested capital = $2,006,000/0.18 = 11,144,444.44 Total invested capital = 11,144,444.44 + 2,980,000 = 14,124,444.44 Total NOPAT = 2,006,000 + 877,920 = 2,883,920 ROI = 2,883,920/14,124,444.44 =0.2041 Present ROI is 20.14%. ROI: Present = 20.14% New product line alone = 29.4% a.. Computation of residual income: Residual income = NOPAT - Cost of capital*Invested capital = 2,006,000 - 15%*11,144,444.44 =1,671,666.666 =1,671,666.666 Residual income for New product line alone = 877,920 - 0.15*2,980,000 = 877,920 - 447,000 = 430,920 Residual income: Present: $1,671,666.66 New product link alone: $430,920 Residual income: Present: $1,671,666.66 New product link alone: $430,920Related Questions
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