Sams Company is a decentralized wholesaler of standard and luxury pet products with five autonomous divisions. The divisions are evaluated on the basis of ROI, with year-end bonuses given to the divisional managers who have the highest ROIs. Operating results for the companys Cat Lovers Products Division for this year are given below:

Sales Variable expenses Contribution margin Fixed expenses Net operating income Divisional average operating assets

$10,000,000 6,000,000 4,000,000 3,200,000 $ 800,000 $ 4,000,000

The company had an overall return on investment (ROI) of 15% this year (considering all divisions). Next year the Cat Lovers Products Division has an opportunity to add a new product line that would require an additional investment that would increase average operating assets by $1,200,000. The line consists of luxury cat beddings and matching cat clothing in very fancy fabrics. The cost and revenue characteristics of the new product line per year would be:

Sales Variable expenses Fixed expenses

$2,300,000 65% of sales $710,000

Computation of ROI

Compute the Cat Lovers Products Divisions ROI for this year. Compute the Cat Lovers Products Divisions ROI for the new product line by itself. Compute the Cat Lovers Products Divisions ROI for next year assuming that it performs the same as this year and adds the new product line.

2. If you were in the manager of Cat Lovers Products Division, would you accept or reject the new product line? Explain.

3. Why do you suppose Sam Companys headquarters is anxious for the Cat Lovers Product Division to add the new product line?

4. Suppose that the Sam Companys minimum required rate of return on operating assets is 12% and that performance is evaluated using residual income.

Compute the Cat Lovers Products Divisions residual income for this year. Compute the Cat Lovers Products Divisions residual income for the new product line by itself.

Compute the Cat Lovers Products Divisions residual income for next year assuming that it performs the same as this year and adds the new product line.

5. Using the residual income approach, if you were the manager of the Cat Lovers Product Division, would you accept or reject the new product line? Explain.