I know headquarters wants us to add that new product line, said Fred Halloway, m
ID: 2504475 • Letter: I
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 divisions return on investment (ROI) has led the company for three years, and I dont 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 companys East Division for last year are given below:
The company had an overall ROI of 18% last year (considering all divisions). The companys East Division has an opportunity to add a new product line that would require an investment of $2,720,000. The cost and revenue characteristics of the new product line per year would be as follows:
Compute the East Divisions 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 companys East Division for last year are given below:
Explanation / Answer
1. East Division's ROI for last year = net operating income / divisional operating assets = 1,778,400 / 5,700,000 = 31.2%
Net operating income for new product line = sales - variable expenses - fixed expenses = 8,432,000 - 8,432,000 *65% - 2,344,096 = 607,104
ROI of new product line alone = net operating income / investment for new product line = 607,104 / 2,720,000 = 22.32%
Net operating income for overall division + new product line = 1,778,400 + 607,104 = 2,385,504
ROI of overall division + new product line = total net operating income / (divisional operating assets + investment for new product line) = 2,385,504 / (5,700,000 + 2,720,000) = 28.33%
2. As ROI is reducing from 31.2% to 28.33% after adding the new product line, Fred Halloway will reject the new product line.
3. Headquarters is anxious for the East Division to add the new product line because Adding the new line would increase the company's overall ROI.
4.a. Residual income for division alone = net operating income - 15%*divisional operating assets = 1,778,400 - 15%*5,700,000 = $ 923,400
Residual income for new product line = net operating income - 15%*investment for new product line = 607,104 - 15%* 2,720,000 = $ 199,104
Residual income for overall division + new product line = total net operating income - 15%*(divisional operating assets+investment for new product line) = 2,385,504 - 15%*(5,700,000+2,720,000) = $ 1,122,504
4.b. As residual income is increasing from 923,400 to 1,122,504 by adding the new product line, Fred Halloway will accept the new product line.
Hope this helped! Let me know in case of any queries.