Problem 11-14 Return on Investment (ROI) and Residual Income [LO1, LO2]
“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:
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|Net operating income||$||1,680,000|
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|Divisional operating assets||$||5,250,000|
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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 $3,000,000. The cost and revenue characteristics of the new product line per year would be as follows:
|Variable expenses||65% of sales|
|Fixed expenses||$ 2,520,000|
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.)
|New product line alone||21 %|
|2.||If you were in Fred Halloway’s position, would you accept or reject the new product line?|
Why do you suppose headquarters is anxious for the East Division to add the new product line?
|Adding the new line would increase the company's overall ROI.|
Suppose that the company’s minimum required rate of return on operating assets is 15% and that performance is evaluated using residual income.
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 "$" sign in your response.)
|New product line alone||$ 180,000|
Under these circumstances, if you were in Fred Halloway's position would you accept or reject the new product line?