Faced with headquarters’ desire to add a new product line, Stefan Grenier, manag
ID: 2574149 • Letter: F
Question
Faced with headquarters’ desire to add a new product line, Stefan Grenier, manager of Bilti Products’ East Division, felt that he had to see the numbers before he made a move. His division’s ROI has led the company for three years, and he doesn’t want any letdown. Bilti 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:
4 Faced with headquarters' desire to add a new product line, Stefan Grenier, manager of Bilti Products' East Division, felt that he had to see the numbers before he made a move. His dMsion's ROI has led the company for three years, and he doesn't want any letdown. Bilti Products is a decentralized wholesaler with four autonomous diisions. The divisions are evaluated on the basis of ROl, 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 $26,600,000 Variable expenses 14,120,000 Contribution margin 12,480,000 Fixed expenses Operating income Divisional operating assets 10,086,000 S 2,394,000 6,650,000 The company had an overall ROI of 16% last year (considering all divisions). The new product line that headquarters wants Grenier's East Division to add would require an investment of $3,800,000. The cost ano revenue characteristics of the new product line per year would be as follows Sales Variable expenses Fixed expenses $11,400,000 65% of sales 3,306,000 Required: 1. Compute the East Division's ROl for last year, also compute the ROl as it would appear if the new product line were added. (Do not round intermediate calculations.) Present New Line Total ROI 2. If you were in Grenier's position, would you accept or reject the new product line? O Accept Reject 3. Why do you suppose headquarters is anxious for the East Division to add the new product line? O Adding the new line would decrease the company's overall ROI. O 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 13% and that performance is evaluated u residual income a. Compute East Division's residual income for last year, also compute the residual income as it would appear if the new product line were added Present New Line Total Residual income b. Under these circumstances, if you were in Grenier's position, would you accept or reject the new product line? O Accept O RejectExplanation / Answer
1. Calculation of Present ROI
ROI = Net operating Profts after Tax / Operatig Assets of division
= 2,394,000 / 6,650,000 = 36%
Calculation of ROI of new line
Operating Income = Sales - Variable costs - Fixed expenses
= 11,400,000 - (65% x 11,400,000) - 3,306,000 = $684,000
Investment i new line = $3,800,000
ROI = 684,000 / 3,800,000 = 18%
Overall ROI = Total operating income / Total assets of Division
Total Operating income = $2,394,000 + 684,000 = $3,078,000
Total assets = $10,450,000
Overall Divisional ROI = 3,078,000 / 10,450,000 = 29.45%
2. New product line proposal should be rejected as it leads to less overall divisional ROI than the current ROI.
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