Chapter 11 Case Study

Chapter 11 Case

“I know headquarters wants us to add that new product line,” said Fred Holloway, manager of Kristi

Products’ West Division. “But I want to see the numbers before I make a move. Our division’s

return on investment (ROI) has led the company for three years, and I don’t want any letdown.”

Kristi 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 West Division for the last year are given below:

Sales………………………. $21,000,000

Variable expenses…………. 13,400,000

Contribution margin………. 7,600,000

Fixed expenses……………. 5,920,000

Net Operating Income…….. $ 1,680,000

Divisional Operating Assets. $ 5,250,000

The company had an overall ROI of 18% last year (considering all divisions). The company’s West

division has an opportunity to add a new product line that would require an investment of

$3,000,000. The cost and revenue characteristics of the new product line per year would be as

follows:

Sales……………………… $9,000,000

Variable expenses………... 65% of sales

Fixed expenses…………… $2,520,000

Required:

1. (2 points) Compute the West Division’s ROI for last year; also compute the ROI as it

would appear if the company duplicated the same performance as last year and also added

the new product line.

2. (2 points) If you were in Fred Holloway’s position, would you accept or reject the new

product line? Explain.

3. (2 points) Why do you suppose headquarters is anxious for the West Division to add the

new product line?

4. Suppose that the company’s minimum required rate of return on operating assets is 15% and

that the performance is evaluated using residual income.

a. (2 points) Compute the West Division’s residual income for the last year; also compute

the residual income as it would appear if the company duplicated the same performance

as last year and also added the new product line.

b. (2 points) Under these circumstances, if you were in Fred Holloway’s position would

you accept or reject the new product line? Explain.