Question

Red Incorporated wants to add a new product line. Red Incorporated is a decentralized wholesaler with five independent divisions. The divisions are evaluated on the basis of return on investment (ROI), with year-end bonuses given to the divisional managers who have the highest ROIs. Operating results for the Office Products Division for 2019 are presented below:

                       

Sales	$10,000,000
Variable Expenses	6,000,000
Fixed Expenses	3,200,000
Divisional Assets	4,000,000

Red had an overall ROI of 15% last year (considering all divisions). The Office Products Division has an opportunity to add a new product line that will require an additional investment in Divisional Assets of $1,000,000. Alex Thomsen is Operations Manager of the Office Products Division. The cost and revenue of the new product line are forecast to be:

Sales	$2,000,000
Variable Expenses	60% of sales
Fixed Expenses	$640,000

Please answer the following:

1. If you were Alex Thomsen would you accept or reject the new product line? You must support answer.
2. Why is Senior Management anxious to add the new product line? You must support your answer.
3. Senior Management is concerned Alex Thomsen will nix the deal. They have hired you an expert Business Consultant to help convince the Board of Directors to move forward with the new product line. Assume the minimum required return for Divisional Assets is 12%. How would you convince the Board to approve the new product line? You must support your answer.

Answer 1

	Opearting Results for 2019
	Sales		$10,000,000
	Less:
	Variable Expenses	6000000
	Fixed Expenses	3200000	9200000
	Net Income		$800,000
	Assets		4000000
	ROI		20	%
	Overall ROI		15%
	New Product Line
	Sales		$2,000,000
	Less:
	Variable Expenses	$1,200,000
	Fixed Expenses	640000	1840000
	Net Income		$160,000
	Assets		1000000
	ROI		16	%
	Summary	ROI %
	Office Product	20
	Overall	15
	New Line	16
1	If I were Alex, then we will not accept this new product line.
	Reason is my division ROI is 20% where as new product line
	gives only 16% ROI which will bring down ROI for my division
	so we will not accept new product line.
2	Senior Management is anxious to have this new project because
	this product is having higher ROI than overall ROI of the divisions.
	It will be beneficial for the company to have higher ROI product line so that
	overall ROI increases.
3	We will show to board of directors that New product line is having more
	ROI % than existing overall ROI of the company. New line will give us
	16% ROI whereas currently total ROI average is 15% only. Further It is
	far ahead from minimum required rate of return of 12%.
	So It will be beneficial for company to accept new product line to increase
	overall ROI