Problem 9-14B Return on Investment (ROI) and Residual Income [LO9-1, LO9-2]

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	$	23,500,000
Variable expenses		14,954,545
Contribution margin		8,545,455
Fixed expenses		6,474,000
Net operating income	$	2,071,455
Divisional operating assets	$	5,875,000

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 $3,730,000. The cost and revenue characteristics of the new product line per year would be as follows:

Sales	$ 11,040,000
Variable expenses	65% of sales
Fixed expenses	$ 3,020,910

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).)

	ROI
Present		%
New product line alone		%
Total		%

+

2.

If you were in Brian Stettlers position, would you accept or reject the new product line?

	Accept
	Reject

3.

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

	Adding the new line would decrease the company's overall ROI.
	Adding the new line would increase the company's overall ROI.

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.

	Residual Income
Present
New product line alone
Total

+

b.

Under these circumstances, if you were in Brian Stettlers position would you accept or reject the new product line?

A.	Accept
B.	Reject