Chapter 23, Problem 23.5CP

Evaluating division performance

Last Resort Industries Inc. is a privately held diversified company with five separate divisions organized as investment centers. A condensed income statement for the Specialty Products Division for the past year, assuming no Service department charges, is as follows:

The manager of the Specialty Products Division was recently presented with the opportunity to add an additional product line, which would require invested assets of $14,400,000. A projected income statement for the new product line is as follows:

The Specialty Products Division currently has $27.000.000 in invested assets, and Last Resort Industries Inc.’s overall rate of return on investment, including all divisions, is 10%. Each division manager is evaluated on the basis of divisional rate of return all investment A bonus is paid, in $8.000 increments, for each whole percentage point that the division’s rate of return on investment exceeds the company average.

The president is concerned that the manager of the Specialty Products Division rejected the addition of the new product line, even though all estimates indicated that the product line would be profitable and would increase overall company income. You have been asked to analyze the possible reasons why the Specialty Products Division manager rejected the new product line.

1. 1. Determine the rate of return on investment for the Specialty Products Division for the past year.
2. 2. Determine the Specialty Products Division manager’s bonus for the past year.
3. 3. Determine the estimated rate of return on investment for the new product line. Round whole percents to one decimal place and investment turnover to two decimal places.
4. 4. - Why might the manager of the Specialty Products Division decide to reject the new product line? Support your answer by determining the projected rate of return all investment for 2016, assuming that the new product line was launched in the Specialty Products Division, and 2016 actual operating results were similar to those of 2015.
5. 5. Can you suggest an alternative performance measure for motivating division managers to accept new investment opportunities that would increase the overall company income and rate of return on investment?