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 (ROI) 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 managers who have the highest ROIs. Here are the operating results for the company’s Outdoor Products Division for last year:
Variable expenses (6,000,000)
Contribution margin 4,000,000
Fixed expenses (3,200,000)
Net operating income $800,000
Divisional operating assets $4,000,000
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 product line. The line would require an additional $1,000,000 investment in operating assets. Here is some of the information about the new product line:
Variable expenses 60% of sales
Fixed expenses $640,000
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. If you were in the manager’s position, would you accept or reject the new product line? WHY? Be sure to explain your answer.
3. Why do you suppose the owners are so interested in having the Outdoor Products Division add the new product line?
4. Suppose that Coleman Company’s minimum required rate of return on operating assets is 12% and that each division’s performance is evaluated using residual income.
a. Calculate the Outdoor Products Division’s residual income for last year and calculate the residual income if the new product line is added.
b. 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.