Question

“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 division’s return on investment (ROI) has led the company for three years, and I don’t 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 company’s Central Division for last year are given below:

Sales	$	22,000,000
Variable expenses		14,000,000
Contribution margin		8,000,000
Fixed expenses		6,174,000
Net operating income	$	1,826,000
Divisional operating assets	$	5,500,000

The company had an overall ROI of 18% last year (considering all divisions). The company’s Central Division has an opportunity to add a new product line that would require an investment of $3,430,000. The cost and revenue characteristics of the new product line per year would be as follows:

Sales	$ 10,290,000
Variable expenses	65% of sales
Fixed expenses	$ 2,870,910

Required:
1.	Compute the Central Division’s 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).)

2.	If you were in Brian Stettler’s 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 company’s minimum required rate of return on operating assets is 15% and that performance is evaluated using residual income.

a.	Compute the Central Division’s residual income for last year; also compute the residual income as it would appear if the new product line is added.

  

b.	Under these circumstances, if you were in Brian Stettler‘s position would you accept or reject the new product line?
	Accept Reject

Answer 1