“I know headquarters wants us to add that new product line,” said Fred Halloway,
ID: 2468735 • 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:
Sales
$
21,000,000
Variable expenses
13,400,000
Contribution margin
7,600,000
Fixed expenses
5,920,000
Net operating income
$
1,680,000
Divisional operating assets
$
5,250,000
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 $3,000,000. The cost and revenue characteristics of the new product line per year would be as follows:
Sales
$ 9,000,000
Variable expenses
65% of sales
Fixed expenses
$ 2,520,000
Required:
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 the "Turnover", "ROI" answers to 2 decimal places and "Margin" answer to 1 decimal place.)
Present
New Line
Total
Sales
Net operating income
Operating assets
Margin
Turnover
ROI
sheet is drawn here
2.
If you were in Fred Halloway’s position, would you accept or reject the new product line?
Accept
Reject
3.
Why do you suppose headquarters is anxious for the East Division to add the new product line?
Adding the new line would decrease the company's overall ROI.
Adding the new line would increase 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.
Present
New Line
Total
Operating assets
Minimum required return
Minimum net operating income
Actual net operating income
Minimum net operating income
Residual income
sheet is drawn here
b.
Under these circumstances, if you were in Fred Halloway's position would you accept or reject the new product line?
Accept
Reject
rev: 12_09_2013_QC_42100, 04_30_2014_QC
“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
1) ROI = Net operating Income / operating Assets Present New Line Total Sales 21000000 9000000 30000000 Net operating Income 1680000 630000 2310000 operating Assets 5250000 3000000 8250000 Margin 7600000 3150000 10750000 Turnover 21000000 9000000 30000000 ROI 32.00% 21.00% 28.00% New line Sales 9000000 Variable expenses 5850000 Contribution Margin 3150000 Fixed Expenses 2520000 Net operating income 630000 East division ROI last year 32.00% East division ROI with new line 28.00% 2) Yes, I would accept the new product line , as the ROI indivisually of the new product line is 21% , which is higher than the required ROI 3) Adding the new line would increase the company's overall ROI 4) Residual Income = net operating income - ( minimum requires return on assets * average operating assets) a) Present New Line Total operating Assets 5250000 3000000 8250000 Minimum required return 15% 15% 15% minimum net operating income 787500 450000 1237500 Actual Net operating Income 1680000 630000 2310000 Residual Income 892500 180000 1072500 b) I would accept the new product line as it has a positive residual income
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