Problem 11-20 Return on Investment and Residual Income [LO3, LO4]

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 divisions ROI has led the company for three years, and he doesnt 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 companys East Division for last year are given below:

Sales	$	25,900,000
Variable expenses		14,030,000
Contribution margin		11,870,000
Fixed expenses		9,539,000
Operating income	$	2,331,000
Divisional operating assets	$	6,475,000

The company had an overall ROI of 18% last year (considering all divisions). The new product line that headquarters wants Greniers East Division to add would require an investment of $3,700,000. The cost and revenue characteristics of the new product line per year would be as follows:

Sales	$	11,100,000
Variable expenses		60% of sales
Fixed expenses	$	3,663,000

Required: 1. Compute the East Divisions ROI for last year; also compute the ROI as it would appear if the new product line were added. (Do not round intermediate calculations. )

2. If you were in Greniers position, would you accept or reject the new product line?

Accept or Reject?

3. Why do you suppose headquarters is anxious for the East Division to add the new product line?

4. Suppose that the companys minimum required rate of return on operating assets is 16% and that performance is evaluated using residual income. a. Compute East Divisions residual income for last year; also compute the residual income as it would appear if the new product line were added.

b. Under these circumstances, if you were in Greniers position, would you accept or reject the new product line?

Accept or Reject?

Present New Line Total ROI Adding the new line would decrease the company's overall ROI. O Adding the new line would increase the company's overall ROI. Present New Line Total Residual income