Question

The manager of Coleman Company's Outdoor Products Division has received word that the company's owners would like the Outdoor Products Division to add a new product line. He wants to look at the numbers and do some comparing before making a decision about adding a new line. As he sees it, his division has had the highest return on investment IRO) in the company for the past three years, and he doesn't want a new product line to change that track record. Coleman Company has five autonomous divisions in its decentralized wholesale operations. Each of the divisions are evaluated on the basis of ROI. Year-end bonuses are awarded to the divisional who have the highest ROls. Here are the operating results for the company's Outdoor Products Division for last year: Sales Variable expenses Contribution margin Fixed expenses Net operating income Divisional operating assets $4,000,000 510,000,000 6,000,000 4,000,000 [3,200,000) 5800,000 Coleman Company as a whole had an overall return on investment of 15% last year(including all divisions). The Outdoor Products Division could add a new pradut ne. The line would require an additional $1,000,000 investment in operating assets. Here is some of the information about the new product line: $2,000,000 60% of sales Variable expenses Fixed expenses 1. Compute the net operating income for the net product line. Then compute the Outdoor Products Division's ROI for last year, the ROI for the new line, and the ROI for the division if the new product line is added. 2. I you were in the manager's position, would you accept or reject the new product line? WHY? 3. Why do you suppose the owners are so interested in having the Outdoor Produets Division add 4. Suppose that Coleman Company's minimum required rate of return on operating assets is 12% Be sure to explain your answer. the new product line? and that each division's performance is evaluated using residual income. Calculate the Outdoor Products Division's residual income for last year and calculate the residual income if the new prod uct line is added. If you are the manager of the Outdoor Products Division and you were being evaluated on the basis of residual income, would you accept or reject the new product line? EXPLAIN. a. b.

Answer 1

1.Computation of net operating income of the new product line:

Sales	2,000,000
Less: Variable Expenses	1,200,000
Contribution Margin	800,000
Less: Fixed Costs	640,000
Net Operating income	$160,000
Investment in Operating Assets	1,000,000
ROI	16%

Outdoor Product Division’s ROI = 800,000/4,000,000 = 20%

2.I would REJECT the new product line since the ROI of the division before adding the new line is 20% and ROI of new line is 16%, it will lower the ROI of the division as a whole. Since, divisions are evaluated on the basis of ROI and bonuses are paid accordingly, I WILL Not add the new line

3.Owners are interests in adding a new product line because the overall ROI of the company is 15% and ROI provided by the new line is 16% which is higher than the current overall ROI. Adding the new line will increase the overall ROI of the company.

4.a.

	Last Year	When new line is added
Net operating income	800,000	960,000
Less: Minimum Required Return (Operating Assets*12%)	480,000	600,000
Residual Income	$320,000	$360,000

b.Yes, I WOULD ACCEPT the new line, since the residual income will increase after adding the new line and performance is being evaluated using the residual income.