Question

Modern Living Inc. is a privately held diversified company with five separate divisions organized as investment centers. A condensed income statement for the Patio Division for the past year, assuming no service department charges, is as follows:
Modern Living Inc.— Patio Division
Income Statement
For the Year Ended December 31, 2011
Sales ......... $18,000,000
Cost of goods sold .... 13,000,000
Gross profit ....... $ 5,000,000
Operating expenses .... 1,400,000
Income from operations . $ 3,600,000
Invested assets ..... $15,000,000

The manager of the Patio Division was recently presented with the opportunity to add an outdoor fireplace product line, which would require invested assets of $4,500,000. A projected income statement for the new product line is as follows:
Outdoor Fireplace Line
Projected Income Statement
For the Year Ended December 31, 2012
Sales ......... $4,050,000
Cost of goods sold ... 2,340,000
Gross profit ....... $1,710,000
Operating expenses ..... 900,000
Income from operations . $ 810,000

The Patio Division currently has $15,000,000 in invested assets, and Modern Living Inc.’s overall rate of return on investment, including all divisions, is 14%. Each division manager is evaluated on the basis of divisional rate of return on investment, and a bonus equal to $10,000 for each percentage point by which the division’s rate of return on investment exceeds the company average is awarded each year.
The president is concerned that the manager of the Patio Division rejected the addition of the new product line, when all estimates indicated that the product line would be profitable and would increase overall company income. You have been asked to analyze the possible reasons why the Patio Division manager rejected the new product line.
1. Determine the rate of return on investment for the Patio Division for the past year.
2. Determine the Patio Division manager’s bonus for the past year.
3. Determine the estimated rate of return on investment for the new product line.
4. Determine the rate of return for the Patio Division if the Outdoor Fireplace product line was added and the 2012 operating results were similar to those of 2011. Round to one decimal place.
5. Why might the manager of the Patio Division decide to reject the new product line?
6. Can you suggest an alternative performance measure for motivating division managers to accept new investment opportunities that would increase the overall company income and rate of return on investment?



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  • CreatedFebruary 04, 2014
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