Homework SourseFaced with headquarters desire to add a new product line Ste
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:
d
The company had an overall ROI of 18% last year (considering all divisions). The new product line that headquarters wants Grenier\'s East Division to add would require an investment of $3,000,000. The cost and revenue characteristics of the new product line per year would be as follows:
d
Required:
Compute the East Division\'s ROI for last year; also compute the ROI as it would appear if the new product line were added.
If you were in Grenier\'s position, would you accept or reject the new product line? Explain.
Why do you suppose headquarters is anxious for the East Division to add the new product line?
Suppose that the company\'s minimum required rate of return on operating assets is 15% and that performance is evaluated using residual income.
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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.
Under these circumstances, if you were in Grenier\'s position, would you accept or reject the new product line? Explain.
Sales ariable expenses Contribution margin. Fixed expenses Operating income Divisional operating assets $21000000 600000 5920,000 1680000 $5,250,000Solution
Answer:
1
Present
New Line
Total
A
Sales.
$21,000,000
$9,000,000
$30,000,000
b
Operating income
$1,680,000
$630,000 *
$2,310,000
c
Operating assets
$5,250,000
$3,000,000
$8,250,000
d
Margin (b) ÷ (A)
8.00%
7.00%
7.70%
e
Turnover (A) ÷ (c ,)
4
3
3.64
f
ROI (d) × (e)
32%
21%
28%
Working notes for the answer:
* Sales
$9,000,000
Variable expenses (65% x $9,000,000).
5,850,000
Contribution margin .
3,150,000
Fixed expenses ..
2,520,000
Operating income ..
$630,000
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2
If you were in Grenier\'s position, would you accept or reject the new product line? Explain
Answer:
SGrenier will be inclined to reject the new product line, since accepting it would reduce his division’s overall rate of return
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3
The new product line promises an ROI of 21%, whereas the company’s overall ROI last year was only 18%. Thus, adding the new line would increase the company’s overall ROI
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4
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
Operating assets ..
5250000
3000000
8250000
Minimum required return .
× 15%
× 15%
× 15%
Minimum operating income
787500
450000
1237500
Actual operating income.
1680000
630000
2310000
Minimum net operating income
787500
450000
1237500
Residual income
892500
180000
1072500
b)
Under these circumstances, if you were in Grenier\'s position, would you accept or reject the new product line? Explain.
Answer:
Under the residual income approach, Stefan Grenier would be inclined to accept the new product line, since adding the product line would increase the total amount of his division’s residual income, as shown above
| Present | New Line | Total | ||
| A | Sales. | $21,000,000 | $9,000,000 | $30,000,000 |
| b | Operating income | $1,680,000 | $630,000 * | $2,310,000 |
| c | Operating assets | $5,250,000 | $3,000,000 | $8,250,000 |
| d | Margin (b) ÷ (A) | 8.00% | 7.00% | 7.70% |
| e | Turnover (A) ÷ (c ,) | 4 | 3 | 3.64 |
| f | ROI (d) × (e) | 32% | 21% | 28% |
