%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 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:
|
|
|
|
| Sales |
$ |
22,400,000 |
| Variable expenses |
|
14,000,000 |
|
|
|
| Contribution margin |
|
8,400,000 |
| Fixed expenses |
|
6,675,200 |
|
|
|
| Net operating income |
$ |
1,724,800 |
|
|
|
| Divisional operating assets |
$ |
5,600,000 |
|
|
|
|
|
The company had an overall ROI of 18% last year. 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:
|
|
|
| Sales |
$ 8,850,000 |
| Variable expenses |
65% of sales |
| Fixed expenses |
$ 2,460,300 |
|
|
| 1. |
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.
|
| 2. |
If you were in Fred Halloway%u2019s position, would you accept or reject the new product line? |
|
|
|
|
| 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. |
|
Adding the new line would decrease the company's overall ROI. |
|
| 4. |
Suppose that the company%u2019s minimum required rate of return on operating assets is 15% and that performance is evaluated using residual income. |
| a. |
Compute the East Division%u2019s 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. |
| b. |
Under these circumstances, if you were in Fred Halloway's position would you accept or reject the new product line? |
|
|
|
|