“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. (Do not round intermediate percentage values. Round your intermediate calculations and final answers to 2 decimal places. Omit the "%" sign in your response.) |
2. |
If you were in Fred Halloway’s 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? |
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. (Omit the "$" sign in your response.) |
b. |
Under these circumstances, if you were in Fred Halloway's position would you accept or reject the new product line? |
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