Problem:
Westwood Inc. is a decentralized organization with five autonomous divisions. The divisions are evaluated on the basis of ROI, with year-end bonuses given to the divisional managers who have the highest ROIs. Operating results for the company's Office Products Division for the most recent year are given below:
Sales $9,000,000
Variable expenses $5,400,000
Contribution margin $3,600,000
Fixed Expenses $2,520,000
Net Operating Income $1,080,000
Divisional operating assets $4,500,000
The company had an overall ROI of 18% last year considering all divisions. The office Products division has an opportunity to add a new product line that would require an additional investment in operating assets of $250,000. The cost and revenue characteristics of the new product line per year would be:
Sales $1,000,000
Variable expenses 60% of sales
Fixed expenses $350,000
Required:
Q1. Compute the Office Products Division's ROI for the most recent year; also compute the ROI as it would appear if the new product line is added.
Q2. If you were in Clem Baker's position, would you be inclined to accept or reject the new product line?
Q3. Why do you suppose headquarters is anxious for the Office Products Division to add the new product line?
Q4. 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 the Office Products Division's residual income for the most recent year; also compute the residual income as it would appear if the new product line is added.
b. Under these circumstances, if you were in Clem Baker's position, would you accept or reject the new product line?