%u201CI know headquarters wants us to add thatnew product line,%u201D said Fred Halloway, manager of KirsiProducts%u2019 East Division. %u201CBut I want to see the numbersbefore I make a move. Our division%u2019s return on investment(ROI) has led the company for three years, and I don%u2019t wantany letdown.%u201D

Kirsi Products isa decentralized wholesaler with four autonomous divisions. Thedivisions are evaluated on the basis of ROI, with year-end bonusesgiven to divisional managers who have the highest ROI. Operatingresults for the company%u2019s East Division for last year aregiven below:

Sales $ 15,300,000
Variable expenses 13,000,000

Contribution margin 2,300,000
Fixed expenses 1,106,600

Netoperating income $ 1,193,400

Divisional operating assets $ 5,100,000

The company had an overall ROI of 18% last year(considering all divisions). The company%u2019s East Division hasan opportunity to add a new product line that would require aninvestment of $2,560,000. The cost and revenue characteristics ofthe new product line per year would be as follows:

Sales $7,680,000
Variable expenses 65%of sales
Fixedexpenses $ 2,119,680


Compute the East Division%u2019s ROI for lastyear; also compute the ROI as it would appear if the companyperformed the same as last year and added the new product line.(Do not round intermediatepercentage values. Round other intermediate calculations and finalanswers to 2 decimal places.)

Present %
New product line alone %
Total %

2. Ifyou were in Fred Halloway%u2019s position, would you accept orreject the new product line?

3. Whydo you suppose headquarters is anxious for the East Division to addthe new product line?
Adding the new line would increase the company's overallROI.
Adding the new line would decrease the company's overallROI.

4. Suppose that the company%u2019s minimum required rate of return onoperating assets is 15% and that performance is evaluated usingresidual income.

a. Compute the East Division%u2019s residual income for last year;also compute the residual income as it would appear if the companyperformed the same as last year and added the new productline.

Residual income
Present $
New product line alone $
Total $

b. Under these circumstances, if you were in Fred Halloway's positionwould you accept or reject the new product line?

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Elin Hessel
Elin HesselLv2
28 Sep 2019

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