Reference no: EM132565917

Question - Centennial Products Ltd is a decentralised wholesaler with four autonomous and independent divisions: East, West, South and North. The performance of divisional managers is evaluated on the basis of return on investments (ROI), with year-end bonuses only awarded to those divisional managers who could achieve the highest ROI on annual basis.

In the last year, the divisional operating assets of the North Division were $5,250,000 and its operating results are provided below:

Sales revenues $21,000,000

Variable costs 13,400,000

Contribution margin 7,600,000

Fixed costs 5,920,000

Net operating profit $1,680,000

The overall ROI of the entire company was 18% last year. Recently, the headquarters requested the North Division to add a product line that would require an investment of $3,000,000. The cost and revenue estimations of the new product line are as follows:

Sales revenues $9,000,000

Variable costs 65% of sales

Fixed costs $2,520,000

The manager of the North Division, Peter Cheung, is reluctant to make the above investment before analysing the numbers as he concerns about the negative impact on his ROI and the loss of annual bonuses as his division has led the company for three years.

Required -

(a) Calculate the ROI, separating the Margin and Turnover, for the North Division:

(i) before adding the new product line

(ii) after adding the new product line

(b) Would the manager accept or reject the new product line? Explain with reasons.

(c) Why the headquarters is anxious for the North Division to add the new product line? Explain with reasons.

(d) Suppose that the company's minimum required rate of return is 15% and that managerial performance is now evaluated on the basis of residual income. Calculate the residual income of the North Division:

(i) before adding the new product line

(ii) after adding the new product line

and explain, with reasons, whether the manager would change his decision that you mentioned in (b) above.