Casual Living Inc. is a privately held diversified company with five separate divisions organized as investment centers. A condensed income statement for the Apparel Division for the past year, assuming no service department charges, is as follows:
Casual Living Inc.—Apparel Division
Income Statement
For the Year Ended December 31, 2009
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Sales …………………………………........……… $22,500,000
Cost of goods sold …………………….……... 16,870,000
Gross profit …………………………….....……. $ 5,630,000
Operating expenses …………………………… 1,130,000
Income from operations …………...…….. $ 4,500,000
Invested assets …………………………..….. $30,000,000
The manager of the Apparel Division was recently presented with the opportunity to add an additional product line, which would require invested assets of $15,000,000. A projected income statement for the new product line is as follows:
New Product Line
Projected Income Statement
For the Year Ended December 31, 2010
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Sales ………………………...........…… $ 9,000,000
Cost of goods sold ………….....…… 5,200,000
Gross profit ……………….......…… $ 3,800,000
Operating expenses …………...….. 2,450,000
Income from operations ……... $ 1,350,000
The Apparel Division currently has $30,000,000 in invested assets, and Casual Living Inc.’s overall rate of return on investment, including all divisions, is 8%. Each division manager is evaluated on the basis of divisional rate of return on investment, and a bonus equal to $9,000 for each percentage point by which the division’s rate of return on investment exceeds the company average is awarded each year.
The president is concerned that the manager of the Apparel Division rejected the addition of the new product line, when 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 Apparel Division manager rejected the new product line.
3. Determine the estimated rate of return on investment for the new product line. Round whole percents to one decimal place.
4. Why might the manager of the Apparel Division decide to reject the new product line? Support your answer by determining the projected rate of return on investment for 2010, assuming that the new product line was launched in the Apparel Division, and 2010 actual operating results were similar to those of 2009.
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?