In: Accounting
Charley's Manufacturing is a decentralized corporation. Divisions are treated as investment centers. In recent years, Charley's has been running about 11% ROI for the corporation as a whole, which is the minimum target for new investment. One of its most profitable divisions is Bens Products, which last year had ROA of 20% ($1,600,000 operating income on assets of $8,000,000). Bens has an opportunity to expand one of its plants to produce a promising new product. The expansion will cost two million dollars and is expected to increase operating earnings to $1,900,000. Required: What factors should Ben's manager and her supervisor, the VP of operations, consider in deciding whether to go forward with the expansion?
Factors to be considered in deciding whether to go forward with the expansion:
1. ROI - The Return on Asset for the new promising product is calculated as = (1,900,000-1,600,000)/2000000 = 15%. This ROI is still higher than the average ROI of 11% for the corporation as a whole. Even though it is less than the current ROI of Ben products of 20% but this expansion can increase the overall ROI of the corporation.
2. Cost of Debt/WACC - The cost of debt and the Weighted average cost of capital needs to be considered before taking the decision on investing into a new product.
3. Availability of funds - It is always useful to take advantage of the "free money" that the corporation has. If they have good amount of idel money and no other project to invest in, it is useful to take up the opportuinity.
4. Opportuinity cost - Before going ahead with the investment, they need to consider what other projects are available to invest in which might even give better ROI that this one. Or they can invest the money to expant the market sales of the current product which is giving best return in the whole corporation.
5. New Product market - It is important to consider the fact that there is a demand for the new product and it satisfies the needs of the customer. Else, the whole investment will give no returns. It can also prove to be advantageous if they build successful product which none of the competitors have and can take full advantage of the monopoly situation.
6. Diversification - The company should always invest in diversified products and projects so as to reduce the risk. It might be the case that the current product of Bens still is most profitable but might not last long. Every product reaches its peak and then starts declining.
7. Innovation - The company should also keep up with the new products laiunched by the competitors in the market. They must innovate and build new products to stay ahead of the competition and be the leader of the market.
8. Synergy - The investment in new promising product line may have less ROI but it can provide synergy benefits to the Bens and the corporation as a whole.
9. Selling and advertising - Since it is a new product, huge cost will need to be spend on advertising the new product, amke the consumers understand the benefits fo rthe same in order to start and increase the sales.