“I know headquarters wants us to add that new product line,” said Fred Halloway,
ID: 2480392 • 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:
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 $2,700,000. The cost and revenue characteristics of the new product line per year would be as follows:
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.)
“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.”
Explanation / Answer
Required: All Amounts in $ 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 42% Present ROI = Net Operating Income / Divisional Operating Assets = 42% New product line alone 20% For the new product added Net Operating Income = Sales - Variable Costs - Fixed Costs = 7,830,000 - (65% of 7,830,000) - 2,208,060 = 532440 $ Investment = $ 2,700,000 Total 62% ROI on New Product alone = 20% 2 If you were in Fred Halloway’s position, would you accept or reject the new product line? a Accept Reject 3 Why do you suppose headquarters is anxious for the East Division to add the new product line? a Adding the new line would increase the company's overall ROI. Adding the new line would decrease the company's overall ROI. 4 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 1566000 Since the minimum required rate of return on operating assets is 15% New product line alone 127440 Present Residual Income = $ 2,436,000 - 15% of $ 5,800,000 = $ 2,436,000 - $ 870,000 = $ 1,566,000 Total 1693440 Residual Income for the New Product Line alone = $ 532,440 - 15% of $ 2,700,000 = $ 532,440 - $ 405,000 = $ 127,440 b. Under these circumstances, if you were in Fred Halloway's position would you accept or reject the new product line? a Accept Reject
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