%u201CI know headquarters wants us to add that new product line,%u201D said Fred
ID: 2375378 • Letter: #
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%u201CI know headquarters wants us to add that new product line,%u201D said Fred Halloway, manager of Kirsi Products%u2019 East Division. %u201CBut I want to see the numbers before I make a move. Our division%u2019s return on investment (ROI) has led the company for three years, and I don%u2019t want any letdown.%u201D
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%u2019s East Division for last year are given below:
The company had an overall ROI of 18% last year (considering all divisions). The company%u2019s East Division has an opportunity to add a new product line that would require an investment of $2,560,000. The cost and revenue characteristics of the new product line per year would be as follows:
Compute the East Division%u2019s ROI for last year; also compute the ROI as it would appear if the company performed the same as last year and added the new product line. (Do not round intermediate percentage values. Round other intermediate calculations and final answers to 2 decimal places.)
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%u2019s East Division for last year are given below:
Explanation / Answer
Sales $ 15,300,000
Variable expenses 13,000,000
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Contribution margin 2,300,000
Fixed expenses 1,106,600
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Net operating income $ 1,193,400
Divisional operating assets $5,100,000
So Margin = 1193400/15300000 = 7.80%
Turnover = 15300,000/5100,000 = 3.00
The company had an overall ROI of 18% last year (considering all divisions). The company East Division has an opportunity to add a new product line that would require an investment of $2,560,000. The cost and revenue characteristics of the new product line per year would be as follows:
1. Compute the East Division ROI for last year; also compute the ROI as it would appear if the company performed the same as last year and added the new product line.
Last Year Margin = 1193400/15300000 = 7.80%
Turnover = 15300,000/5100,000 = 3.00
SO ROI = 7.80%*3 = 23.40% ........Ans
After ading new prodiuct line:
New Op Assets = 5100000+2560000 = 7660000
New Sales = 15,300,000 + 7680000 = 22980000
So Total Turnover = 22980000/7660000 = 3.00 No Change
Sales $ 7,680,000
Variable expenses65% of sales= 4992000
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COnt Margin 2688000
Less Fixed expenses $ 2,119,680
------------------------------------
Net Op Income 568320
New Product Margin = 568320/7,680,000 = 7.40%
New Product Turnover = 7,680,000/2,560,000 = 3.0
So New Product ROI = 7.4%*3 = 22.20%...Ans
So New Total Margn = Total Op Inc/Total Sales
= (568320+ 1,193,400)/22980000
= 7.67%
So Total ROI = 7.67%*3 = 23.01% .............Ans
ROI
Present 23.40 %
New product line alone 22.20%
Total 23.01%
2. If you were in Fred Halloway position, would you accept or reject the new product line?
Reject As Total ROI is less than Old ROI.
3. Why do you suppose headquarters is anxious for the East Division to add the new product line?
Adding the new line would increase the company's overall ROI.
4. Suppose that the company minimum required rate of return on operating assets is 15% and that performance is evaluated using residual income.
a. Compute the East Division residual income for last year; also compute the residual income as it would appear if the company performed the same as last year and added the new product line.
Residual Income = Net Op ncome - (COst of capital*AVge Op Asset)
So Last Year Resi Inc = 1193400 - 15%*5100000 =428400
New Prod Line Resi Inc = 568320 - 15%*2560000 =184320
Total Resi Inc = 428400+184320 = 612720
Residual income
Present 428,400
New product line alone 184,320
Total $612720
b. Under these circumstances, if you were in Fred Halloway's position would you accept or reject the new product line?
Accept As Residualincome has Increased by 184320/612720 = 30.08%
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