Question
5. Smith and Weston Company is a decentralized organization with five autonomous divisions. The divisions are evaluated on the basis of the return that they
5. Smith and Weston Company is a decentralized organization with five autonomous divisions. The divisions are evaluated on the basis of the return that they are able to generate on invested assets, with year-end bonuses given to the divisional managers who have the highest ROI figures. Operating results for the companys Industrial Products Division for the most recent year are given below:
Sales $8,000,000
Less variable expenses 5,000,000
Contribution margin 3,000,000
Less fixed expenses 900,000
Net operating income. $ 2,100,000
Divisional operating assets. $ 12,000,000
The company had an overall ROI of 14% last year (considering all divisions). The Office Products Division has an opportunity to add a new product line that would require an additional investment in operating assets of $1,000,000. The cost and revenue characteristics of the new product line per year would be:
Sales.. $2,000,000
Variable expenses. 60% of sales
Fixed expenses.. $ 650,000
Required:
- Compute the Office Products Divisions ROI for the most recent year; also compute the ROI as it will
appear if the new product line is added.
- If you were in Dell Havasis position, would you be inclined to accept or reject the new product line?
Explain.
- Do you think headquarters would want the Industrial Products Division to add the new product
line?
- Suppose that the company views a return of 12% on invested assets as being the minimum that any
division should earn and that performance is evaluated by the residual income approach.
- Compute the Industrial Products Divisions residual income for the most recent year; also
compute the residual income as it will appear if the new product line is added.
- Under these circumstances, if you were the manager of the Industrial Products Division, would you accept or reject the new product line? Explain.
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