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5. Smith and Weston Company is a decentralized organization with five autonomous divisions. The divisions are evaluated on the basis of the return that they are able to generate on invested assets, with year-end bonuses given to the divisional managers who have the highest ROI figures. Operating results for the company’s Industrial Products Division for the most recent year are given below:

                  Sales…………………………………………              $8,000,000

                           Less variable expenses………………………     5,000,000

                           Contribution margin…………………………     3,000,000

                           Less fixed expenses…………………………                   900,000

                           Net operating income……………………….    $ 2,100,000

                           Divisional operating assets…………………. $ 12,000,000

The company had an overall ROI of 14% 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 $1,000,000. The cost and revenue characteristics of the new product line per year would be:

                                         Sales………………………..              $2,000,000

                                         Variable expenses………….        60% of sales

                                         Fixed expenses……………..   $   650,000

Required:

1. Compute the Office Products Division’s ROI for the most recent year; also compute the ROI as it will

appear if the new product line is added.

2. If you were in Dell Havasi’s position, would you be inclined to accept or reject the new product line?

Explain.

3. Do you think headquarters would want the Industrial Products Division to add the new product

line?

4. Suppose that the company views a return of 12% on invested assets as being the minimum that any

division should earn and that performance is evaluated by the residual income approach.

1. Compute the Industrial Products Division’s residual income for the most recent year; also

compute the residual income as it will appear if the new product line is added.

2. Under these circumstances, if you were the manager of the Industrial Products Division, would you accept or reject the new product line? Explain.