Cases of manejerial decision

Grate Company concentrates his efforts producing personal care products. The company operates six divisions, including Division of
hair care. each Division is treated as an investment centre. the manager is evaluated and rewarded based on performance ROI. Only
for the best ROI producing managers are eligible to receive a bonus and filling higher managerial positions. Fred Oldsen, hair care
Division Manager, has always been one of the best managers. During the last two years, resulting in the highest Division Fred ROI; last
year the Division that resulted in a net operating profit of $ 2.46 million and using the average operating assets valued at $ 16 million.
Fred proud of his performance and get information that if his work this year so he was nominated to fill higher positions at central office .
For the coming year, the Fred Division has promised additional capital new valued at $ 1.5 million. Each additional unused capital
Division will be invested by the company to produce a minimum rate of return of 9 percent. After studying it carefully, marketing and
engineering staff recommends that Division invested in machinery makers curling irons, products that are currently not produced
divisions. These machines cost estimated at $ 1.2 million. Manager of Marketing Division, predicted that the net profit of the new line is
$ 156.000 per year.
After studying the potential impact of this proposal, Fred refused to forward it. He next wrote a memo to corporate central office said that
his Division was not able to use the additional capital are offered for new projects in eight to ten months. However, he notes that he was
sure that the marketing and engineering staff will be ready to start a new project by the end of next year. To that end, Fred want to be at
the end of next year he still denied access capital gain.
Quetion
1.
2.
3.
4.
5.

Explain why Fred Olsen rejected the proposal to add to its versatility to produce a curling iron. Make the calculations to
support your reasons.
Calculate the impact of the new product line of the company's overall profitability. Should Fred Division produces a curling
iron?
Suppose that companies use profit as a measure for the performance of residue divisional. Whether the decision of Fred
may be different? Why?
Explain why a company like Grate Care using residual profits and returns on investment as a measure of performance.
Whether Fred shows ethical behavior when it refused to make an investment? In discussing this issue, consider why he
refuses to make an investment?

Answer :
1.

Because we think, if adding a capability of producing a curling iron, it has lowered the value of ROI risk Fred Division.
This can be explained by the following calculation:

Before:
Operating income
$2.560.000
Average operating assets
$16.000.000
% ROI (Opr. Income/Av Opr Assets)
16%

After :
$2.743.000 ($2.560.000 + $156.000)
$17.500.000 ($16,5 millions +$1,5 millions)
15,67%

2.

If Fred Division performs addition of new products, then its Operating Income would have increased but the percentage
of ROI Fred Division down from 16% to 15,67%. so can degrade performance of Fred, because company managers are
rewarded based on performance ROI.

3.

If the company uses the Residual Return decision, decision companies possibly is different because the residue profit
increases.

Average operating assets

Operating income
Minimum Return(9% of Av Opr Assets)
Residual Income

Before:
$16.000.000
$2.560.000
$1.440.000
$1.120.000

After:
$17.500.000
$2.743.000
$1.575.000
$1.168.000

4.

Because if she used ROI methods,her as if loss, but when using Residual Income we can see the profit increased by $
48,000 ($ 1.168.000-$1.120.000)

5.

in our opinion, Fred shows the ethical behavior when he refused to make an investment. Because if we explain using a
combination of ROI and RI then known as follows:

Average operating assets

Operating income
Minimum Return(9% of Av Opr Assets
Residual Income
Residual Return(% of RI/Av Opr Assets)

Before:
$16.000.000
$2.560.000
)$1.440.000
$1.120.000
7%

After:
$17.500.000
$2.743.000
$1.575.000
$1.168.000
6,67%

From the above calculation can be known that, with residual income methods profitof the company increased $ 48,000
from the past year when adding to its versatility. But, if viewed from the efficiency of that, then company became less
efficient because of the profit the company become bigger ,but it does give a great influence to the Operating income.