%u201CI know headquarters wants us to add that new product line,%u201D said Fred
ID: 2376583 • 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 $3,100,000. 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 new product line is added. (Round your intermediate calculations and final answers to 2 decimal places. Omit the "%" sign in your response.)
%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. Present ROI = net operating income / assets = 1,927,800/5,100,000 = 37.8%
New product line operating income = 9,300,000*(1-65%)-2,613,300 = 641,700
New product line ROI = 641,700 / 3,100,000 = 20.7%
Total net operating income = 1,927,800+641,700 = 2,569,500
Total assets = 5,100,000+3,100,000 = 8,200,000
Total ROI = 2,569,500 / 8,200,000 = 31.33%
2. Fred should reject as his ROI is decreasing from 37.8% to 31.33% on adding this new product line. As his bonus is dependent on the ROI, he should reject this product line.
3. Adding the new line would increase the company's overall ROI.
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