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	$	23,100,000
Variable expenses		13,670,000
Contribution margin		9,430,000
Fixed expenses		7,582,000
Operating income	$	1,848,000
Divisional operating assets	$	7,700,000

   

The company had an overall ROI of 12% last year (considering all divisions). The new product line that headquarters wants Grenier’s East Division to add would require an investment of $4,950,000. The cost and revenue characteristics of the new product line per year would be as follows:

Sales	$	9,900,000
Variable expenses		70% of sales
Fixed expenses	$	2,277,000

   

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. (Do not round intermediate calculations. )

	Present New Line Total ROI % % %

2.	If you were in Grenier’s position, would you accept or reject the new product line?
	Accept Reject

3.	Why do you suppose headquarters is anxious for the East Division to add the new product line?
	Adding the new line would increase the company's overall ROI. Adding the new line would decrease the company's overall ROI. Choose the right statement

4.	Suppose that the company’s minimum required rate of return on operating assets is 10% 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.
	Present New Line Total Residual income

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

Answer 1

Net product line net operating income = 9900000*(1-70%)-2277000= $693000
Margin = Net operating income/Sales
Turnover = Sales/Operating assets
ROI = Margin*Turnover
1
	Present	New line	Total
Sales	23100000	9900000	33000000
Net operating income	1848000	693000	2541000
Operating assets	7700000	4950000	12650000
Margin	8.00%	7.00%	7.70%
Turnover	3.00	2.00	2.61
ROI	24.00%	14.00%	20.09%
2
Reject, as ROI decreases
3
Adding the new product line would increase company's overall ROI
4a
	Present	New line	Total
Operating assets	7700000	4950000	12650000
Minimum required return	10%	10%	10%
Minimum Net operating income	770000	495000	1265000
Actual Net operating income	1848000	693000	2541000
Minimum Net operating income	770000	495000	1265000
Residual income	1078000	198000	1276000
b
Accept, as residual income increases