Question
I know headquarters wants us to add that new product line, said Brian Stettler, manager of Sparks Products Central Division. But I want to see
I know headquarters wants us to add that new product line, said Brian Stettler, manager of Sparks Products Central Division. But I want to see the numbers before I make a move. Our divisions return on investment (ROI) has led the company for three years, and I dont want any letdown.
Sparks 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 companys Central Division for last year are given below: |
Sales | $ | 22,900,000 |
Variable expenses | 14,572,727 | |
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Contribution margin | 8,327,273 | |
Fixed expenses | 6,354,000 | |
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Net operating income | $ | 1,973,273 |
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Divisional operating assets | $ | 5,725,000 |
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The company had an overall ROI of 15% last year (considering all divisions). The companys Central Division has an opportunity to add a new product line that would require an investment of $3,610,000. The cost and revenue characteristics of the new product line per year would be as follows: |
Sales | $ 10,740,000 |
Variable expenses | 65% of sales |
Fixed expenses | $ 2,960,910 |
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Required: | |
1. | Compute the Central Divisions 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 final answers to 2 decimal places (i.e., 0.1234 should be entered as 12.34).) |
2. | If you were in Brian Stettlers position, would you accept or reject the new product line? | ||||
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3. | Why do you suppose headquarters is anxious for the Central Division to add the new product line? | ||||
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4. | Suppose that the companys minimum required rate of return on operating assets is 12% and that performance is evaluated using residual income. |
a. | Compute the Central Divisions residual income for last year; also compute the residual income as it would appear if the new product line is added. |
b. | Under these circumstances, if you were in Brian Stettlers position would you accept or reject the new product line? | ||||
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