%u201CI know headquarters wants us to add that new product line,%u201D said Fred
ID: 2375691 • Letter: #
Question
%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 $2,950,000. 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.)
%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
Explanation / Answer
1. ROI for last year = operating income / total assets = 1,724,800 / 5,600,000 = 30.8%
Operating income for new line = 8,850,000*(1-65%)-2,460,300 = 637,200
ROI only for new line = 637,200/2,950,000 = 21.6%
Total ROI for this year = (1,724,800+637,200) / (5,600,000+2,950,000) = 27.63%
2. I would reject the new line as it leads to decrease in the ROI from 30.8% to 27.63%. As ROI is the basis on which bonuses are given, this will impact my bonus.
3. The headquarters is likely keen as the ROI of the new line taken on standalone basis is 21.6% which is higher than the overall company ROI of 18%. So adding the new line would increase the company's overall ROI.
4.
1. Residual income for last year = 1,724,800 - 15%*5,600,000 = 884,800
Residual income for new product line = 637,200 - 15%*2,950,000 = 194,700
Total Residual income for this year = 1,724,800 + 637,200 - 15%*(5,600,000 + 2,950,000) = 1,079,500
2. Under these circumstances, I would accept the new product line as the residual income will increase on addition of the new line, leading to increased bonuses.
Hope this helped ! Let me know in case of any queries.
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