Question

Faced with headquarters’ desire to add a new product line, Stefan Grenier, manager of Bilti Products’ East Division, felt that he had to see the numbers before he made a move. His division’s ROI has led the company for three years, and he doesn’t want any letdown. Bilti 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 East Division for last year are given below:
Sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \$21,000,000
Variable expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,400,000
Contribution margin. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,600,000
Fixed expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,920,000
Operating income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \$ 1,680,000
Divisional operating assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \$ 5,250,000
The company had an overall ROI of 18% last year (considering all divisions). The new product line that headquarters wants Grenier’s East Division to add would require an investment of \$3,000,000. The cost and revenue characteristics of the new product line per year would be as follows:
Sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \$9,000,000
Variable expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65% of sales
Fixed expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . \$2,520,000
Required:
1. Compute the East Division’s ROI for last year; also compute the ROI as it would appear if the new product line were added.
2. If you were in Grenier’s position, would you accept or reject the new product line? Explain.
3. Why do you suppose headquarters is anxious for the East Division to add the new product line?
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 East Division’s residual income for last year; also compute the residual income as it would appear if the new product line were added.
b. Under these circumstances, if you were in Grenier’s position, would you accept or reject the new product line? Explain.

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