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Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094

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BuyFindarrow_forward

Accounting

27th Edition
WARREN + 5 others
ISBN: 9781337272094
Textbook Problem

Evaluating division performance

 Last Resort Industries Inc. is a privately held diversified company with live 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:

Last Resort Industries Inc.—Specialty Products Division

Income Statement

For the Year Ended December 31,20Y5

Sales $32,400,000
Cost of goods sold 24,300,000
Gross profit $8,100,000
Operating expenses 3,240,000
Income from operations $4,860,000
Invested assets $27,000,000

 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:

New Product Line

Projected Income Statement

For the Year Ended December 31,20Y6

Sales $12,960,000
Cost of goods sold 7,500,000
Gross profit $5,460,000
Operating expenses 3,127,200
Income from operations $ 2,332,800

 The Specialty Products Division currently has $27,000,000 in invested assets, and Last Resort Industries Inc.’s overall return on investment, including all divisions, is 10%. Each division manager is evaluated on the basis of divisional return on investment. A bonus is paid, in 58,000 increments, for each whole percentage point that the division’s 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 the Specialty Products Division manager rejected the new product line.

  1. 1. Determine the 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 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 return on investment for 20Y6, assuming that the new product line was launched in the Specialty Products Division, and 20Y6 actual operating results were similar to those of 20Y5.
  5. 5. Suggest an alternative performance measure for motivating division managers to accept new investment opportunities that would increase the overall company income and return on investment.

(1)

To determine

Return on investment (ROI): This financial ratio evaluates how efficiently the assets are used in earning income from operations. So, ROI is a tool used to measure and compare the performance of a units or divisions or a companies.

Formula of ROI:

Return on investment = Income from operationsInvested assets

Residual income: The remaining income from operations after deducting the desired acceptable income is referred to as residual income.

Formula of residual income:

Income from operations XXX
Less minimum acceptable income from operations as a percent of invested assets XXX
Residual income XXX

Table (1)

To determine: The ROI of SP Division

Explanation

Compute ROI of SP Division.

Return on investment = Income from operationsInvested assets

(2)

To determine

To compute: The bonus of the SP Division manager

(3)

To determine
The ROI of the new product line

(4)

To determine

To discuss: The reasons as to why the division manager would likely reject the new product line

(5)

To determine

To recommend: Any new financial performance measures to convince the manager to accept the new product line

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